James Pethokoukis

Politics and policy from inside Washington

The conservative case for a VAT

Dec 16, 2010 16:26 UTC

Over at NRO, Duncan Currie gives it his best shot:

Despite being more efficient than an ordinary sales tax, a VAT carries significant administrative costs, and piling it on top of the present U.S. tax structure would be a mistake. But using the VAT to eliminate a sizable amount of distortionary U.S. income taxes would yield a far more growth-friendly system than the one we have today. Over the long run, America must reorient its economy away from consumption and toward investment while boosting its dangerously low savings rate. A VAT is certainly not the only way to promote those objectives, but it should at least be part of the conversation.

In the piece,  Currie more or less outlines a proposal similar to what Gov. Mitch Daniels suggest a month or so ago: Lower existing taxes rates and add a VAT.  I don’t believe he means for this to be a tax increase. Higher government revenue would come from higher economic growth.  Of course, many liberals see a VAT as an efficient way to dramatically raise taxes. Roger Altman, perhaps the replacement for Larry Summers in the White House, has recommended a $500 billion VAT.

In theory, I don’t have a problem with the Currie-Daniels approach, though I would prefer to have the income tax repealed. I also don’t think it would automatically lead to higher and VAT taxes and higher and higher spending — especially not after reading this piece. As Currie notes:

Moreover, while the VAT can lead to higher spending, it does not inevitably have that effect. Consider what happened in Canada, where the Progressive Conservative government of Brian Mulroney implemented a federal VAT in 1991. Since then, as economists William Gale and Benjamin Harris of the Urban-Brookings Tax Policy Center point out, “the size of the Canadian federal government has shrunk significantly.” The VAT rate started at 7 percent, but it has fallen to 5 percent under the Conservative government of Prime Minister Stephen Harper, which has also slashed corporate taxes.

In New Zealand, it was a neoliberal Labour government that embraced the controversial consumption tax. During the mid-1980s, Prime Minister David Lange and his finance chief, Roger Douglas, spearheaded a radical program of fiscal consolidation that included massive income-tax reductions, deep spending cuts, ambitious deregulation, and a 10 percent VAT.

COMMENT

Gale + Harris also mention that there is a sub-national level of VAT in many of the Canadian provinces which is added on to the federal rate, resulting in total VAT rates as high as 13%. Other provinces (the “hold-outs”) who have not harmonized their provincial sales taxes with the federal GST to form the Harmonized Sales Tax “HST”, continue to impose single stage sales taxes, which, unlike the VAT / HST, are not recoverable by way of deduction or input tax credit. This is with the exception of the natural resource rich province of Alberta which has no provincial sales tax. From 2013 Canada intends to impose a Corporate Tax rate of 15%. Certainly a decent model for any US VAT architects to look at.

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Sarah Palin vs. Simon Johnson and Washington wisdom

Dec 16, 2010 15:33 UTC

This is the kind of thing that really burns me. Here is Simon Johnson, former chief economist at the IMF, over the at the NYTimes econ blog:

The weakness in the Palin-Gingrich position is that while they want to balance the budget, they want to do so primarily by cutting spending. This is very difficult to do, as most of the spending issues over the next 30 years are about Social Security (a little) and Medicare (a lot). …

Cutting or limiting nonmilitary discretionary spending may play well with voters, but it is simply not big enough to make much difference. If Ms. Palin and Mr. Gingrich are willing to put military spending on the table, that would help, but this is fast becoming a taboo subject for all Republicans.

Of course, Johnson is being absolutely ridiculous here. Palin has flat out endorsed Paul Ryan’s fiscal Roadmap for America, a blueprint for radically restructuring entitlements. He is also wrong that cutting defense spending is taboo among Republicans. Plenty of conservatives, at least, think there are lots of smart cuts that could be made. But Washington insiders like Johnson —  and most of the people I hear give presentations at symposiums around town —  think just like he does. They assume spending can’t be cut, thus taxes must be raised dramatically. So when Palin  and Ryan and other true budget hawks actually say “Yes, lets revamp entitlements,” it just doesn’t penetrate their noggins. They can’t take “yes’ for an answer.

Then there’s this: Since 1980, some 30 debt-plagued nations have tried to reduce their indebtedness through such austerity measures as spending cuts and higher taxes. In practically all cases, according to a study by financial giant UBS, the increase in national debt was only slowed, not reversed, by such policy pain.  … [Faster growth] is typically how successful countries in the UBS study managed to get their books in order; they grew their economies faster than they added debt.  And that means keeping taxes low.

COMMENT

Is Mr. Pethokoukis — are you — serious?

Much like this hollow post, the Roadmap for America is big on general talk and completely thin on details or actual plans. Roadmaps are laudatory and constructive when they present a vision, but can also be obfuscatory when used as stall tactics (both the post and the Roadmap for America are of the latter type).

And that’s for the very reason that Mr. Johnson points out — that Republicans aren’t really serious about cutting military spending or any other entitlements that damage their political popularity. Mr. Pethokoukis, you should read Mr. Johnson’s article, entitled “Paul Ryan is Not a Fiscal Conservative,” which is available free of charge: http://baselinescenario.com/2010/11/04/p aul-ryan-is-not-a-fiscal-conservative/. Perhaps a substantive response would serve you readers best.

Also, the notion that Simon Johnson is somehow your standard “Washington insider” is a lazy and transparent way of saying “I don’t like what he says.” Beyond that, it’s also absurd. Johnson has been highly critical of most Washington policies, ranging from Dodd-Frank, the bailouts, Obama’s light posture towards banks and financial institutions, etc. If you’re not willing to do your research, perhaps you could go as far to choose a more appropriate, albeit hollow, dismissive term.

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Obama’s CEO Meeting: the Uncertainty Principle lives!

Dec 15, 2010 22:46 UTC

So the POTUS met with a bunch of CEOs:

President Barack Obama, trying to improve strained relations with the corporate world, prodded America’s top business executives on Wednesday to spend more money to boost U.S. hiring and the economy. ”We focused on jobs and investment and they feel optimistic that, by working together, we can get some of the cash off the sidelines,” Obama told reporters after spending more than four hours with 20 company leaders to discuss job creation.

Obama wanted to pick the brains of America’s business executives, and he estimated they were sitting on around $2 trillion that could be deployed to employ more U.S. workers. The meeting with corporate bosses, including Jeffrey Immelt, chief executive of General Electric Co, and John Chambers, chief executive of Cisco Systems Inc, took place as the U.S. Senate passed tax cuts sought by companies.

A few thoughts:

1) Is is demand or uncertainty? Well, we just ran a 2-year experiment where we flooded the economy with economic and monetary stimulus while at the same time wrecking business incentives via tax and regulatory threats. The results have not been pretty.

2) Obama’s meeting with CEOs is itself evidence that the White House also believes that it has negatively affected business attitudes which has increased their caution. This also why they have been trying, unsuccessfully, to find a CEO to replace Larry Summers.

3) Here is a fun fact: In 2007, a year the economy grew 1.9 percent, there were 250 IPOs raising some $60bln. Although the economy is growing faster than that this year — and despite a big IPO backlog — IPOs activity is only half what it was in 2007. That goes right to the issue of animal spirits.

4) There’s a rich vein of academic research supporting the premise that policy uncertainty can paralyze the private sector. America’s Great Depression may have been extended thanks to “regime uncertainty,” or the New Deal’s avalanche of regulation and taxes. Federal Reserve Chairman Bernanke offered a similar explanation for poor U.S. economic performance in the 1970s. In his MIT thesis, Bernanke partly blamed the decade’s weak business investment on “uncertainty” about long-term domestic policy, concluding that “caution is the order of the day for investors.”

COMMENT

Another fine column, James.

It’s not clear, at least to me, whether Mr. Obama has truly absorbed the lessons of the recent mid-terms OR if he’s just play-acting. Time will tell, I suppose, but I find it hard to believe that Bill Clinton hasn’t had a chat with Mr. Obama – especially after this tax cut business – about political reality and the need to go with the flow.

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Obama and CEOs finish year warmer but still wary

Dec 15, 2010 19:02 UTC

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

President Barack Obama’s meeting Dec. 15 with U.S. business leaders is a symbolic step towards mending the White House’s longstanding rift with Corporate America. That should complement other business-friendly steps, such as a Korea trade agreement and bipartisan tax deal. But to truly narrow Obama’s schism with CEOs, corporate tax and regulation reform need to be high on the administration’s 2011 agenda.

More immediately, CEOs may be mildly disappointed with Obama’s next move, picking a replacement for Larry Summers as director of the National Economic Council. The administration has few members with significant experience outside of government. Summers’ departure created an opening, the chieftains hoped, for someone who has built a business and met payroll. An investment banker isn’t quite what Main Street CEOs probably had in mind. Still, leading candidate and Evercore founder Roger Altman would be preferable to short-listers like Gene Sperling, NEC director under President Bill Clinton; or Yale’s Richard Levin. Altman, after all, runs a successful public company.

Longer term, the more important decision for business will be the White House’s emerging effort at revamping the complex and uncompetitive corporate tax code. If Tokyo follows through on efforts to lower its rates, it would leave Japan tied with the United States as having the highest levy on business among advanced industrial economies. While the Treasury Department is still cooking up a proposal, lowering the top U.S. rate as well as replacing the current system of depreciation allowances with an immediate deduction for investments would be a good bridge to business — and potentially lower unemployment.

Business would also like some regulatory relief after this year’s sweeping rule changes in healthcare and finance. On that front, the White House should consider a proposal from Senator Mark Warner, a Virginia Democrat and cofounder of Nextel. His simple plan: For every new regulation a federal agency wants to impose on business, it must eliminate an existing rule. Republicans would surely applaud. And if the policy focused regulators on truly important matters, it could actually make for more effective regulation.

But dealing with the deficit is still the biggest overhang. In a new report, the Congressional Budget Office notes that under current law, public debt will exceed $16 trillion by 2020, with annual interest payments reaching 3.4 percent of GDP. Just a 1 percent rise in long-term interest rates would tack on another trillion to that total. As the CEOs will surely tell Obama, they’d be unlikely to run their businesses with similar fiscal characteristics.

Obamacare doesn’t ‘bend the curve,’ it just breaks the law

Dec 14, 2010 02:28 UTC

Instead of “bending the curve,” Obamacare broke the law. Not only is the new healthcare law fiscally unsustainable, it’s unconstitutional — at least according to a U.S. judge in Virginia.

In the end, of course, it will likely be the Supreme Court that determines the constitutionality of a key piece of President Barack Obama’s healthcare reform. If the majority should rule that Americans can’t be forced to buy insurance or face a fine — as the law would require — the entire plan could implode.  But whichever way the high court rules, the massive overhaul will itself need an overhaul, if not a complete scrapping, if America is going to get healthcare spending under control and prevent it from bankrupting the U.S. government.

While the White House is certainly displeased with the Virginia court’s ruling, the result could have been far worse. U.S. District Judge Henry Hudson said that while the mandate itself was unconstitutional, the finding didn’t infect the rest of the law, which could continue to be implemented. Trouble is if the Supreme Court eventually finds the individual mandate portion unconstitutional, Obamacare could still easily unravel.

Much of the reform is built around a simple tradeoff. Insurers are required to accept everyone who applies. In return, everyone has to buy a policy. While this means insurers have to accept folks with expensive pre-existing illnesses, they are theoretically compensated with more customers, both sick and healthy. But without the individual mandate, an adverse selection problem emerges — only sick people currently lacking coverage would have an incentive to seek insurance.

Jonathan Gruber, a healthcare economist at Massachusetts Institution of Technology and government adviser, calculates that such a scenario would reduce the law’s gain in insurance coverage by more than two-thirds — 80 percent of people without insurance would remain that way — and force companies to raise premiums on individuals by 40 percent. As he puts it: “Without the individual mandate, the entire structure of reform would fail.”

In short, the U.S. healthcare system would get even pricier while still leaving vast numbers of Americans without insurance. A more expensive system would mean government healthcare spending would rise even faster.

Even if the White House overturns the Virginia ruling, the system would still require major reform. A detailed review of the law’s fiscal impact by Obama’s own chief healthcare actuary predicts it will save less than originally envisioned. The increase in long-term Medicare hospitalization outlays, for instance, is still scheduled to double to 4 percent of GDP from under 1.7 percent currently. A preliminary forecast estimated the increase at as little as 30 percent.

So even if the law should meet the standard of constitutionality, it fails another standard — of sustainability. And there’s no court of appeal for that.

COMMENT

1. Auto insurance mandate !

Under historical interpretations of the Constitution, Congress can dictate the economic activity of citizens so long as that activity will have profound, large-scale effects on the national economy.
 
2. Health insurance protects you PLUS all !
 
** Inaction cost, $9trillion over the next decade, ((Some of CBO analysis : While the costs of the financial bailouts and economic stimulus bills are staggering, they are only a fraction of the coming costs from Social Security, Medicare, and Medicaid. Over the next decade, the Congressional Budget Office (CBO) projects that each year Medicaid will expand by 7 percent, Medicare by 6 percent, and Social Security by 5 percent. These programs face a 75-year shortfall of $43 trillion–60 times greater than the gross cost of the $700 billion TARP financial bailout)).

Among the thirty-three industrialized countries in the world, only America has no universal health care. Why do all the leading countries require participation in a universal plan? Because every other country understands that health care is not only a basic right, it is also a necessity, a sane policy protecting the country from plagues and epidemics but also from bankruptcy by providing modern and uniform health care for its people.

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Sarah Palin’s huge 2012 move: She endorses Paul Ryan’s ‘Roadmap’

Dec 10, 2010 15:55 UTC

With one op-ed piece in the WSJ, Sarah Palin has made a lasting impact on the dynamic of the upcoming Republican presidential race — even if she doesn’t run. (Though I think she will.) By strongly endorsing Rep. Paul Ryan’s outstanding Roadmap for America’s Future, Palin has set a floor for how radical and sweeping an agenda the 2012 candidates can offer. Anyone offering less will look timid and inconsequential and most un-Tea Party-esque. One of the big knocks against Ryan’s plan is that few of his colleagues are supporting it. Now the most high-profile Republican in America has given it her seal of approval. The Ryan Roadmap is quickly becoming the de facto GOP economic platform.  And if Palin does decide to run, she immediately starts out with  a specific and coherent agenda.  Candidates beware: Bullet points and platitudes aren’t going to cut it.

COMMENT

Fresh off her pronouncements on the Fed’s “quantitative easing” and federal aid to the states, Sarah Palin now adds the deficit and Medicare to her Potemkin façade of policy expertise. This is more than a little ironic for the propagator of the “death panels” myth. As it turns out, Ryan’s plan would inevitably lead to the rationing of the Medicare program on which 46 million American seniors now depend.

Hoping to lead the party that tried to block Medicare in the 1960′s and gut it in the 1990′s, Palin is endorsing Ryan’s proposal to cure what ails the health insurance system for millions of American seniors by killing it. When Ryan unveiled his Roadmap back in February, privatization of Medicare was the centerpiece. But because the value of Ryan’s vouchers fails to keep up with the out-of-control rise in premiums in the private health insurance market, America’s elderly would be forced to pay more out of pocket or accept less coverage.

George W. Bush’s disastrous drive to privatize Social Security helped undermine his presidency. Now, in the wake of a Wall Street meltdown that evaporated the retirement savings for countless thousands of Americans, the Republican Golden Boy Ryan is calling for an encore.

Yeah. Ryan is the one Republicans should be considering for president or VP. Go for it.

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The Obama-GOP tax deal in one chart

Dec 9, 2010 20:10 UTC

Here is the breakdown:

txdeal

Is the Obama-GOP tax deal about to collapse?

Dec 9, 2010 19:21 UTC

Things may be going swimmingly in the US Senate, but not so the House:

WASHINGTON (Reuters) -House of Representatives Speaker Nancy Pelosi will not bring President Barack Obama’s current proposed tax plan up for a vote in her chamber, an aide said on Thursday.

The aide said Pelosi would require changes be made to the measure that most of her fellow House Democrats formally opposed by approving a resolution of opposition to it. The aide said: “She (Pelosi) will honor the resolution.”

It’s simple: If the Bush tax cuts are not extended, the US risks falling back into recession next year. At the very least, the markets believe that and will act accordingly. Not to mention what a disaster this would be for the Obama presidency:

The obvious lesson, if the deal collapses, will be that Obama can’t deliver anything – he can be pushed into compromise with GOP priorities, as he wouldn’t before the election, but he can’t bring along his own caucus, which has suffered so many losses for following his lead. Liberals will learn that they are better off striking their own distance from an unpopular and increasingly impotent leader. And heavy liberal opposition to the deal will make it impossible to blame DeMint or Republicans for the collapse, and will encourage conservatives to push for even fewer compromises with Obama in 2011. That calculus of legislative forces will make it hard for Obama to plan for the other leg of the Clinton strategy, a budget battle in which the GOP blinks. Obama can try to use the whole mess to argue that “Washington is broken” and all that, but it’s a hard argument to make from the Rose Garden.

By failing to ensure ahead of time the support of his own caucus, President Obama may have shot himself in the foot in dealing with the Republican-controlled House even before the new majority is sworn in.

COMMENT

Bernie Saunders has the right idea. Reject for now, and then insist on a proper deal in January with threat of filibuster in the Senate and Veto from President Obama.

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Economists weigh in on Obama-GOP tax deal

Dec 8, 2010 21:53 UTC

The always enlightening David Gitlitz of  High View Economics likes the cut of its gib:

I think you’re underestimating the impact of this deal. Sure, a “permanent” cut would be better (although there’s really no such thing as any “permanent” change in the tax code). But the thing to keep in mind is that with this package, a huge tax hike is avoided. That expected hike has been priced in the market and among businesses. That’s one big reason this recovery is so weak. So avoiding the tax hike actually amounts to a tax cut. Even if it’s only for two years, that’s still a huge relief. And who’s to say we won’t get another extension in two years, an election year? Is Obama gonna want to stand for a tax increase when he’s running for reelection? And there’s serious talk on Capitol Hill that this deal could set the stage for fundamental tax reform if the GOP takes control of both houses of Congress and the presidency in 2013. I’m bullish on this deal and what it means for the economy.

Most economists do seem to be bullish, though not always for the same reason. Brian Wesbury of First Trust:

The trade off for an extension of unemployment benefits is full-expensing on plant and equipment for coporations for at least the next two years.  We say “at least” because we think it’s likely that once enacted for two years that this part of the proposal morphs into a permanent feature of the business tax code, regardless of the election in 2012.  Trading a temporary boost in unemployment benefits (which stood no chance of being defeated) for full-expensing is a huge win for the economy.

And finally, the Social Security tax rate will be temporarily cut to 4.2% from 6.2% (for the employee, not employer).  This idea has been around for quite some time and is essentially, the “least bad” kind of Keynesian stimulus, the one least likely to do harm and most likely to support short-term growth.  For people earning above the $106,800 cap, the payroll tax cut is like a lump sum transfer of $2,136 per worker with zero change to incentives.  For most earners below the wage cap, it’s a 2 point reduction in their marginal tax rate, with a small positive effect on the incentive to work.

Some conservative politicians and analysts are complaining about the tax cut deal announced last night.  Some are even considering not supporting it.  They do not like the extension of unemployment benefits and some income tax credits (for children, etc.) that the deal proposes to make available to more people at low income levels who don’t actually pay income taxes anyhow.  This is not good policy.  However, when looked at in terms of total cost, these deals are still well worth the other improvements to policy.  In the end, the compromises are minor, not major.  The message of this deal is that “tax rates matter and lower rates are better.”

Mike Feroli of JPMorgan:

For fiscal year 2011, we are now looking for a fiscal deficit of $1.5 trillion, up from $1.2 trillion. … For fiscal year 2012, we have revised up our deficit forecast from $1.1 trillion to $1.2 trillion.

If we assume that about 2/3rds of this $120 billion [payroll tax cut] windfall gets spent that should add about 0.8%-point to consumer spending growth next year, and about 0.5%-point to GDP growth. ..  Most of the other elements of the compromise are neutral for our forecast; e.g. the income tax rates, jobless benefits, and lower-income credits are all merely a continuation of the status quo. One element that is not part of the status quo is the change in depreciation allowances to allow total expensing. As we discussed when the President first proposed this in September, we see very limited impact on capital spending. In a nutshell, our argument appealed to the fact that the experience with partial expensing over the past decade gave very little evidence that this materially affected firms’ capital spending decisions. Furthermore, the very low level of current interest rates further reduces the time value of realizing depreciation tax shields sooner rather than later.

The implied boost to growth from the increase in income and spending should lower the unemployment rate by 0.3%-pt by year-end 2011.

And here is the econ team at Goldman Sachs:

Q: What are the implications for unemployment, inflation, and Fed policy?

A: Fairly small.  On unemployment, a simple but very useful rule of thumb (Okun’s Law) is that every extra percentage point of growth should bring down the unemployment rate by roughly ½ percentage point.  Of course, there are a variety of considerations here, but the basic relationship is fairly consistent over time.  So the GDP effects discussed above would imply an improvement of perhaps ¼- ½ percentage point in the unemployment rate by end 2011.   Given this small impact on spare capacity and the time it would take to occur, the impact on inflation in 2011 would be essentially zero and likely de minimus in 2012 as well.   Other things equal, a better growth outlook would make it a closer call that the Fed extends asset purchases beyond mid-2011, and implies a slightly earlier
onset of tightening.

Q: Are you going to change your forecasts to reflect the new fiscal package?

A: Probably yes, if the bill passes in a form similar to what was revealed yesterday.  As noted above, the likely upgrade would be between ½ and 1 percentage point to 2011 real GDP growth, although this will of course depend on the final form of the bill and a number of specific assumptions about timing and spending effects.

Good reviews to from Macroeconomic Advisers:

Based upon what is currently known of these three key proposals, our preliminary analysis suggests that GDP growth in 2011 would be boosted by roughly 1/2 to 3/4 percentage point.  This is on top of the 3.7% growth of GDP anticipated for 2011 in our recently published forecast.  Growth in 2012 could also be expected to be several tenths of a percentage point higher, with modest drag on growth in 2013, as the temporary provisions expire.  This analysis assumed that interest rates were unchanged from the baseline.

COMMENT

You don’t have to print the nutty Gitlitz statement so often in comments: that repetition of inane propaganda is pure Jos. Goebbels stuff. Come to think of it, Gitlitz’ doctrinaire, thought-deprived opinion is also pretty Nazi-oid. Like the other Nazis, he needs a truth squad, so here’s the non-Nazi take on it: 1- tax hike/extension didn’t do much anyway for last 10 years: wages stagnant, real growth trivial, deficit blown out since at best 1/3 of a tax cut is retrieved as taxes (and most of that thru bracket-creep). 2- speaking of creeps, Gitlitz is also wrong about pricing in tax “cuts”: biz always has an eye on taxes, but as one of the wiser commentators mentioned,it’s more about opportunity and perceived risk (as in nonimpact of accelerated depreciation schedules). 3- since “cuts” have been there for 8-10 years, they have little impact other than the dramatically huge extension of cap gains break. 4- So why does Pethokoukis bring in crackpot economists — is Gitlitz the Nazi the ringer, kinda like every village needs its idiot?

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More on states going bankrupt, this time with added Felix Salmon goodness

Dec 8, 2010 21:52 UTC

Felix Salmon — who, like me, works at Reuters but, unlike me, is officially a citizen of no nation and operates from a specially modified Yakovlev “Yak” 77 that only lands to refuel and take on provisions — comments on my post about GOP plans to push states into bankruptcy:

If it were implemented, or if it even looked like it might get implemented, prices of municipal bonds would plunge, and most states would find it pretty much impossible to borrow money. As such, facing a massive and immediate liquidity crisis, they would be in more need of a federal bailout than before the bankruptcy legislation was seriously mooted.

The fact is that there’s only one reason to invent a Chapter 8 bankruptcy provision for states—and that’s to come up with an efficient and legal way to impose losses on bondholders and other creditors. (Chapter 9, which applies to cities and other municipal entities, doesn’t apply to states.) The creditors, fully aware of this, would immediately cease lending, certainly to the rockier states like California, Illinois, and New York. That’s not what we want. As a result, unless or until those states can bring their budgets into a primary surplus, introducing such a provision would certainly do more harm than good. And if those states can bring their budgets into a primary surplus, then we don’t need the bankruptcy provision, since they’ll be easily capable of rolling over their debts.

If the states had a bankruptcy provision all along, then I’m sure some people would be thinking seriously about whether it made sense for one or more states to file. But they don’t, and there’s basically no way of getting there from here. As such, the idea’s a non-starter.

Wow, states not being able to borrow. That sounds more like a feature than a bug to me. This would give governors like Chris Christie another tool in their arsenal. Look for legislation along this line next year.

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