Addressing the Next State Fiscal Crisis: Toward an Ex Ante Scheme of Federal Assistance to States in Fiscal Distress

Every several years, usually after a national recession, and also as a result of the C OVID 19 pandemic, states enter financial difficulties. These difficulties spur a debate, both in the political arena and in the academic literature, concerning the appropriate federal response. Some advocate for federal bailouts to rescue the distressed states, while others argue that the states need to deal with their troubles independently or with the help of state bankruptcy legislation. The Article explores the proper federal response to states’ fiscal fiscal crises. The Article argues that the current (suggested) responses – state bankruptcy and ex-post discretionary federal bailout – are problematic solutions. On the one hand, a bankruptcy procedure is inadequate to deal with state economic crises, but on the other hand discretionary bailouts often come too late and create moral hazard and political agency concerns. Instead of these ex-post solutions, the Article suggests the adoption of an ex ante federal assistance scheme. This scheme employs automatic fiscal stabilizers and the Federal Reserve’s authority as a lender of last resort, in order to assist states to deal with economic downturns as they develop. It is designed to induce the recovery of the states’ and the national economies by enabling states to address their fiscal fiscal crises without implementing destructive contractionary measures