Democracy and Debt

Abstract

Recent state and municipal budget crises have generated a great deal of consternation among market participants and policymakers; they have also led scholars to debate the merits of bailouts or other forms of debt relief. This Essay considers why the mechanisms that were supposed to control state and local fiscal behavior ex ante have not worked. In the aftermath of the state and municipal debt crises of the nineteenth century, states adopted a series of constitutional reforms intended to constrain state and local fiscal behavior. In addition, the debt markets and the Tieboutian market in jurisdictions should theoretically prevent states and municipalities from overspending. Neither the fiscal constitution in the states nor the markets have prevented state and local fiscal difficulties, however; indeed, they have arguably contributed to those difficulties. Nevertheless, much of the current debate over bailouts and state bankruptcy reprises the longstanding skepticism of ordinary state and local political processes. This Essay argues that this distrust of local democratic decisionmaking is unwarranted, that efforts to constrain fiscal politics are destined to fail, and that the solution to state and local fiscal crises is largely a matter of politics and not a matter of institutional design.

Keywords: state bankruptcy, bailouts, budget crises, fiscal constitution, debt crises, sovereign debt, municipal debt, state debt

JEL Classification: H72, H74, H77