Across the nation, states are reeling from the economic damage of the COVID-19 pandemic to their budgets on both the revenue and the expenditure sides. The idea of expanding Chapter 9 of the US bankruptcy code to allow state governments to file for bankruptcy has resurfaced. While allowing states to declare bankruptcy would provide some transparency and rule of law, it could give legislatures a clean slate without providing incentives to change the source of their financial problems and would require residents of fiscally prudent states to bail out those that refuse to live within their means.

In this policy brief, Veronique de Rugy and Todd Zywicki illustrate the current economic situation and explicate the arguments for and against state bankruptcy. Political realities – especially those pertaining to the sizable power of special interest groups – must be taken into account when reviewing any proposed reforms. However, state bankruptcy measures are likely to be a better alternative than state bailouts or debt repudiation if strictly enforced.