Heating up is the issue of whether the next COVID-19 bill to be considered by Congress will include massive assistance from the federal to state and local governments, especially those most strapped. If enacted, this will involve the federal government borrowing even more in the credit market to be able to achieve the transfer.

Why, you might ask, don’t the state and local governments go to the credit markets themselves? After all, it’s their citizens who will be saddled with paying the debt costs down the road, whether the borrowing is undertaken at the national level or the state level. Isn’t this a more cumbersome way to get the job done?

There are a couple of reasons why the focus is on the federal government. First, all but one state operates under a constitutional or statutory provision that requires a balanced operating budget to be enacted (the exception is Vermont). This limits the ability of the states to address demands on their budgets from the COVID crisis by borrowing. In many cases, there are ways to tap credit markets to address true emergencies.

Second, the federal government has much more capacity to borrow than all of the individual states combined. The reason for this goes back to the early days of our republic. Alexander Hamilton, the first Secretary of the Treasury, realized that it was necessary for the survival of the new nation to have ready access to credit markets. In the event of a national emergency—he was thinking of a war threat—it was going to be critical to be able to respond by ramping up spending quickly, and this meant, practically, getting the funds from credit markets. But who, in such circumstances, would lend to a new country with no track record of paying its debts? Furthermore, several of the states that had become components of the new republic had defaulted on debt they had issued during the Revolutionary War. It was, therefore, going to be critical to send a clear signal to potential creditors that this new republic was good for its promise to repay. To create this signal, Hamilton proposed that the federal government assume all of the debt of the states, including the defaulted debt that was selling for pennies on the dollar at the time. This was a contentious issue in Congress at the time—and Hamilton’s opponents accused him of trying to profit personally from this scheme—but it was enacted.

The outcome has been that the federal government has never defaulted on its debt and has been able to raise funds at will. Moreover, it has been able to borrow at some of the most favorable terms on the planet—even huge amounts.

In contrast, the states vary considerably in their credit standing and cannot access the large amounts of the federal government. Moreover, a number of those states face severe discipline from creditors because their fiscal positions have eroded so much over the years that issuing more debt now would greatly compound budget strains in the future. These states already have such high tax rates and other restrictions that they are losing population, especially taxpayers, to other states. And creditors know that any more debt by these states will only accelerate outmigration and jeopardize repayment. The result is a serious dilemma for the states that entered the crisis with major budget problems.

In contrast, prospective greater federal budget strains from borrowing are not having the same effect on prompting outflows of taxpayers from the country. Where would they go? Thus, the federal government is being looked upon for raising funds to cover large state and local budget shortfalls under the COVID crisis (and in some cases, shortfalls beyond those caused by COVID). If these efforts succeed, taxpayers leaving the high-tax states won’t be escaping the burdens after all and will still be tabbed for some of the bills. Nor will future generations of Americans, wherever they may reside.

A major concern is that there is only so much more room for using the credit market to finance more spending. The closer we get to that point, the more we risk being unable to respond to the next emergency.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s