The Consequences of a Federal Bailout for the States

Rachel del Guidice /

As lawmakers debate over a bailout for the states, Jonathan Williams, the chief economist and executive vice president of policy at the American Legislative Exchange Council, has a warning for states.

“Strings that come with these federal dollars oftentimes outlive the federal dollars, as we’ve found out with the last time we had a bailout of the states during the Obama era,” Williams says. “And I think it’s just a dangerous precedent to set that the states would look to the federal government to be their solution for problems that they are well-equipped to handle themselves.”

He joins The Daily Signal Podcast today to talk about why states should say no to a federal bailout, if federal bailouts affect states’ rights and sovereignty, if federal bailouts potentially affect tax rates, and much more.

We also cover these stories:

The Daily Signal podcast is available on Ricochet, Apple Podcasts, Pippa, Google Play, or Stitcher. All of our podcasts can be found at DailySignal.com/podcasts. If you like what you hear, please leave a review. You can also leave us a message at 202-608-6205 or write us at letters@dailysignal.com. Enjoy the show!

Rachel del Guidice: We are joined today on The Daily Signal Podcast by Jonathan Williams. He’s the chief economist and executive vice president of policy at the American Legislative Exchange Council. Jonathan, it’s great to have you on The Daily Signal Podcast.

Jonathan Williams: Thank you for having me. Good to be with you.

Del Guidice: Well, it’s great to have you with us. I want to talk to you about a piece that you recently co-authored that appeared in The Hill, and it was titled “States Should Say ‘No Thanks’ to a Federal Bailout.” So to just start things off, why should states say “no”?

Williams: Well, I’ll tell you what, for an organization such as ours at ALEC, and certainly yours being affiliated with Heritage Foundation, our good friends there, we care about the principle of federalism.

And we think that the power ought to be decentralized outside of Washington D.C., and, of course, that was the goal of the American Founders.

If we believe in that principle, and everyone who does believe in that principle, or should believe in that principle, should be very concerned about any time the federal government comes in, perhaps even with the best intentions, to send money to the states to bail them out over perhaps poor decisions that they’ve made in the past, instead of letting states govern and make some of those difficult decisions themselves.

Whenever you have that federal influence, of course, states cede control to the federal government, and these strings that come with these federal dollars oftentimes outlive the federal dollars, as we’ve found out with the last time we had a bailout of the states during the Obama era.

I think it’s just a dangerous precedent to set that the states would look to the federal government to be their solution for problems that they are well-equipped to handle themselves.

Del Guidice: Looking at what’s happened in the past, and what’s happening now with states asking for these bailouts due to the fallout from the coronavirus pandemic economically, is this a new thing or have states always asked for bailouts?

Williams: Well, I’ve been doing this a long time, Rachel, and I’ve seen it happen.

Ten to 11 years ago when we saw the so-called shovel-ready projects during the Obama era and the financial crisis, there was a group of states, and I think it’s important to differentiate between all states and perhaps some states that asked for bailout funds or some legislators within those states.

I helped to lead the educational efforts on behalf of ALEC, and at the time, Speaker Bill Howell in the state of Virginia against some of the other groups that were pushing for a bailout of the state, such as NCSL, a taxpayer-funded organization out there, state lawmakers, NGA, the Group of Governors, League of Counties, and some of the others that were pushing for bailout.

And sometimes it does come down to many cases, and this is a little bit oversimplifying, but states that maybe have overspent, or racked up massive unfunded pension liabilities, or perhaps gotten themselves into the trouble financially are more likely to ask for federal support than states that have made the hard decisions.

Every year in “Rich States, Poor States,” our report, we point out the states like Utah, and Texas, and Tennessee, and Florida, states that are governed well and keep spending in check.

A lot of times those state lawmakers are much more suspect of federal involvement because they don’t want to see federal strings attached that could perhaps cause that loss of state autonomy that we talked about a minute ago.

Del Guidice: What do you think will happen if states don’t get a bailout? Is there any risk to people’s pension plans or anything of that like?

Williams: It depends on, I think, the state-by-state scenario, what the ultimate outcome will be if there’s no federal bailout of states.

Some states will clearly go in and do what every family and every small business would do, and that is do kitchen table budgeting and say, “What do we have? What do we need? What do we want? And how do we make our current revenue fit our spending desires and our spending needs?”

There’s going to be a number of states that are going to just roll up their sleeves and do that hard work, like they should do, and create a priority-based budget for their citizens and protect taxpayers.

Now, there will be states, I’m sure, without federal support that will go back to taxpayers that have been hit hard during this period—maybe lost a job, maybe a small business that had to shutter its doors for a period of time because of health guidelines—and they will go back to them and ask for more in terms of tax dollars. And those will be painful decisions in perhaps both of those scenarios.

That being said, though, whether states get it right or get it wrong, getting back to the first principle of federalism, again, it’s important that states and governors and state lawmakers have that ability to solve the problem, that they see how to solve it best for their citizens within their states, instead of having some sort of one-size-fits-all solution.

Del Guidice: If federal bailouts do happen and states receive them, will states’ rights be effected as well as state sovereignty?

Williams: Absolutely. I often said, “A dollar has never gone from Washington without strings attached.”

One time when I was in the states and used that analogy, a legislator stopped me in my tracks and said, “No, these aren’t strings, these are chains that come from Washington, D.C., with the dollars.”

And they think back at what happened in 2009 with the so-called maintenance of effort requirements that went out with those dollars in the Obama era, and those requirements lasted far longer than many of the dollars.

So that’s been one of the big concerns of fiscally prudent state lawmakers is, there’s no such thing as a free lunch, as Milton Friedman taught us years ago, is that the federal government will require all kinds of new regulations and put requirements on states when it sends dollars to states.

Utah’s a great example of a state that has tried to push back or at least get an inventory of what these costs might be, Idaho has been another state.

I know Indiana under Gov. Mike Pence at the time and now Gov. [Eric] Holcomb in Indiana have looked at ways to put a price tag on, what [do] the federal regulations actually cost us? Because we know they’re not free when these dogs come, how do we know how costly they are?

Then, in some cases, those states will say, “Yeah, thanks, but no thanks. Even if that federal money is out there, we don’t think it maybe is a good idea to take it.”

That whole process, they call it Financial Ready Utah, they started the process and other states have followed suit. I think it’s been something that’s an important element right now to talk about, whether states end up getting this money appropriated from Congress or not.

Del Guidice: What about the whole tax situation when it comes to these bailouts? Could federal bailouts potentially affect federal or even state taxes?

Williams: Well, we know, in this era of $24 trillion now and counting of federal debt, that that’s going to have to be paid at some point, right? This cannot continue for the long term.

I was going back into my notes as I was getting ready for this policy fight ahead of us on a bailout of states, and I was looking at my notes from 2009.

It really did catch me by surprise that in 2009, when we were having this very similar discussion of a bailout of states, the federal debt stood at about $10 trillion. Today we’re at $24 trillion.

Clearly, in one long business cycle, that’s done a whole lot of damage to our national competitiveness. And then once we’re through this crisis, we absolutely need to take steps to get our federal fiscal house in order.

But adding trillions of dollars in proposed new spending that we’ve seen proposed within Congress or in case of bailout of states, maybe in the range of $500 billion alone going to state and local governments, that clearly is not sustainable going forward.

I think those that really do care about the future of the United States, our debt crisis that we do face, and our competitiveness, really is what will we do to try to make up for those debts numbers, should all have something really big at stake for this debate over a bailout of states, as well as future appropriations coming from Congress.

Del Guidice: Congress passed, as we all know, the $2 trillion CARES Act. And then on Friday, President [Donald] Trump signed a $484 billion coronavirus relief package that gives more funding for hospitals and testing as well as small businesses.

Now House Speaker Nancy Pelosi is saying she doesn’t want Congress to return to D.C. until they are ready to go on more coronavirus relief legislation that will include passing vote by mail.

Given all these moving parts and pieces, and as a fiscal expert yourself, what do you think Congress should do when it comes to acting responsibly in legislating recovery for states?

Williams: First of all, I was really pleased to see a letter recently put out by my friend, Congressman Jim Banks of Indiana, a former ALEC member in the Indiana Legislature, now a real leader in Capitol Hill.

With the Republican Study Committee talking about how any new need that would be appropriated from Congress—and let’s face it, there will be real needs ahead of us because of this pandemic and the crisis—those things should be offset, though, by other areas of spending reduction.

I think that’s a really great way to help reprioritize federal spending, like we were talking about states need to prioritize.

I think that idea is a great starting point because there will be needs for more appropriations as we go ahead and try to recover nationally, but let’s make sure we’re not adding and racking up debt on the federal credit card anymore.

And you look at what longer-term the federal government could do, look at what the president actually proposed in the budget that came from the Office of Management and Budget and Russ Vought over there, the director, former Heritage alum, and a good friend of our conservative cause.

They actually called for, in the budget this year, a lot of people missed this, but for real fiscal rules to say whether it’s like Colorado’s Taxpayer Bill of Rights that keeps spending in check by not letting it grow faster than population and inflation. It’s been something that’s really saved Colorado taxpayers now for 25 years.

Whether it’s something like the switch debt break that’s worked well in in Switzerland, or other ways to control government spending and control debt going forward, I think there’s the short-term answer of offsets.

I think that’s really important that Congressman Banks is working on. But then we need to have a longer and a bigger discussion over long-term ways to control federal spending, which is the driver, of course, of federal debt.

Del Guidice: In your piece, Jonathan, you noted, and you mentioned this during our conversation too, that states like Utah and Idaho have wisely implemented financial ready policies. Can you talk a little bit about how these work, and are they an alternative that you would recommend?

Williams: I think it’s wonderful public policy. In fact, ALEC has adopted it as model policy as an organization, starting with Utah, Idaho, and other states that have looked at this concept, and that is basically we need to first of all have an inventory of federal funds.

Believe it or not, a lot of times federal funds will go out and there’s not nearly as much oversight as one might expect and taxpayers really deserve when those funds go to state or local governments.

I think it’s one of those things where Utah took the lead, a lot of our ALEC members and good friends in the Legislature were part of that effort, but they brought some of the best minds of the private sector and public sector together and said, “Let’s have a commission and let’s study these funds. Let’s get an inventory of them first, but then let’s see if federal support goes down.”

I think it’s a question really of when it goes down versus if it goes down, given that we have $24 trillion and heading quickly north, unfortunately, at the national level.

What are the steps, in Utah’s case, that their state government will take to make sure that they fund core services, even absent federal dollars?

And that’s been something that I think has been beautiful for a public policy environment, it’s been something that the bond rating agencies have actually pointed to when they’ve given Utah AAA bond rating.

They said that Utah has a good contingency plan put in place in order to protect vulnerable citizens and protect core functions of government spending when federal support is reduced.

So I think first step is getting the inventory and having a real handle on the cost and regulations that come with federal funds.

Then, secondly, is prioritizing to say, if and when the federal government does reduce support to the states or local budgets, what are the steps that state and local policymakers want to have in place where it’s not a free-for-all situation, and then it becomes really chaotic at that point at the state or local level?

Del Guidice: Jonathan, also in your piece, you talked about how North Carolina drastically lowered its personal and corporate income tax rates and built a rainy day fund, where Illinois, on the other hand, their rainy day fund would only keep the state running for about 15 minutes.

Can you talk about the differences of approach here, and how states can be more like North Carolina?

Williams: It’s really a great case study, it’s really a tale of two states, so to speak, and the very radically different ways of state governance.

That’s one of the pieces we wanted to highlight in our recent op-ed on state bailouts is, there’s a huge divergence among groups of states out there.

Many are doing the right things and trying to do what North Carolina has done now over a decade, starting with Speaker Thom Tillis, who’s now in the U.S. Senate, and now with leaders in North Carolina continuing on that path to reducing income taxes, keeping spending really in check now for about a decade, really keeping it within a population and inflation growth metric, which we talked about as being kind of the gold standard of Colorado’s Taxpayer Bill of Rights.

And they’ve reaped a huge benefit. They’ve seen massive amounts of in-migration from other states, hundreds of thousands of new taxpayers coming to North Carolina.

They’ve gotten their rates down to such an effect where, not only just personal income taxes are very important for economic growth at the state level, but business income taxes.

In fact, North Carolina has the lowest business income tax rate of a state with a corporate income tax, at 2.5%.

When I go around the country and ask people what they think North Carolina’s corporate rate might be, they’re often wildly off on their projections. You get kind of a gasp to say, “Wait, their corporate rate’s only 2.5%?”

It’s been a huge calling card for new business development in North Carolina.

The way that they were able to do that, of course, is keep spending in check, make sure they’re paying down on their unfunded pension liabilities and health care liabilities, they’re stocking up their unemployment insurance fund—which is really coming in handy, obviously, right now with the massive amount of new claims—and they stocked away a billion dollars in their rainy day fund, which is, obviously, going to come in very handy in the midst of the pandemic.

So that’s the kind of scenario where if a one-size-fits-all federal bailout comes from D.C. to the states, it is penalizing North Carolina taxpayers, who have actually, their lawmakers have done the heavy lifting and done the right thing on the budget and cutting taxes.

But it would be a huge boon for states like, let’s say Illinois, that you mentioned, where their rainy day fund would last something comically short, in terms of 15 minutes of covering state operations.

They have massive, hundreds of billions of dollars of unfunded liability and state debt, one of the worst-funded pension systems in America. I think The Wall Street Journal called Chicago “Puerto Rico on Lake Michigan” in terms of its financial situation.

So there couldn’t be two radically more different states. It’s clear, though, that a lot of folks in Illinois are going to be lobbying very heavily for the federal bailout to try to bail out their bad decision-making, while, unfortunately, the people paying the price for that will be federal taxpayers, and many of those taxpayers in states that have actually done the right thing.

That’s the core of the unfairness of the federal bailout.

Del Guidice: You also gave the example in your piece in The Hill about how in 2002, Washington actually closed a $2.5 billion budget gap without raising taxes under the Democrat leadership of Gov. Gary Locke and bipartisan legislatures. Can you talk about how you would encourage governors to take similar actions today?

Williams: I think the Washington state example with priority-based budgeting is one of the very best shining examples of a state that has followed the model of kitchen table budgeting and small business budgeting that goes on every single week across the United States in deciding needs versus wants, and doing heavy lifting at the state level.

Because, let’s face it, federalizing problems doesn’t make them magically go away.

At the end of the day, states are going to need to get to the bottom of a systemic issue of overspending and really packing away massive financial liabilities into the future while not covering them in current budgets.

Washington state, under Democrat leadership, Gary Locke, who went on to serve in the Obama administration as secretary of commerce, with a bipartisan group of lawmakers said, “Our economy is too weak, we’re not going to be able to withstand a tax increase.”

I think it’s safe to draw that parallel to many states’ situations today in the wake of the pandemic. And they said, “We’re going to need to prioritize budget reform over tax increases.”

So, at the end of the day, fast forward through this long, kind of arduous process of deciding what the core functions of government would be, deciding what the real estimates were on amount of revenue, and then making sure that that available amount of revenue went to fund things that got back to the core functions of government.

They did that and they solved the budget problem, a $2.5 billion deficit at the state level, without a dime of tax increases going through this, I think, really revolutionary way of budgeting that states all across the country should be looking to replicate.

Del Guidice: How would you encourage legislators to work to achieve financial discipline as they continue to work on coronavirus bailout legislation? And as one quick follow-up, if lawmakers continue to approve federal handouts to states, what could potential repercussions be?

Williams: When it comes to the federal handouts to states, … first of all, you’ve got the huge moral hazard problem, which is—I’ve been doing this long enough to have gone through a cycle or two of business cycles, and seen this play out a few times before—the inclination is always to overspend while the economy is hot.

We’ve had four or five years in a row of really good revenue growth, thanks to the strong national economy, and tax cuts, and regulatory relief from the Trump administration and Congress, and now states were reaping those benefits and they spent, in many cases, every last dime during the good years.

They don’t prepare for the bad years, unfortunately, except in the cases like we talked about with North Carolina and others who really did stock away for a rainy day.

Then there’s the moral hazard problem where, if they’re expecting a federal bailout every time this happens, more federal handouts to the states, then I think you have to ask yourself, does the politician in a state like Illinois have an incentive to actually ever behave in a fiscally responsible way in the future, if they can just count on a federal handout and federal bailout every time that we have some sort of a national downturn?

Incentives matter in economics, not just in the overall macroeconomic sense, incentives to individual policymakers and individual states matter.

I think it’s really important, whether we’re talking about a bailout, whether we’re talking about the potential ability of states to go into a bankruptcy-type proceeding has been talked about recently in the national headlines, it’s really essential that the incentives are correct in order to make sure that there’s not the moral hazard problem of states overspending and then realizing that they can socialize those costs and those liabilities out across the rest of the country when times are bad.

Del Guidice: Jonathan, thank you so much for breaking this down for us and for joining us today on The Daily Signal Podcast. It’s been an honor to have you.

Williams: It’s great to be with you, and stay safe and stay healthy.