Download: Direct Democracy and State Fiscal Crises: The Problem of Too Much Law

From SSRN a highly recommended paper from Peter Conti-Brown
Stanford University, Rock Center for Corporate Governance

Abstract:

The recent scholarly and policy debate concerning state fiscal crises has appropriately focused on the question of the money states have committed to their employees, bondholders, and citizens, and the implications of economic recession for those promises to pay. In that sense, the debate is not strictly about state fiscal crises, but state debt crises, and proposals to resolve them focus on ways in which the states can restructure their debts without triggering further fiscal decline. This focus on debt is understandable. The collective debts of the several states are staggering, and frequently rely on unrealistic projections of tax and pension fund growth that, during an economic recession, may render the states unable to meet those obligations.

But what if the problem facing the American states is not simply a problem of too much debt, but the more insidious problem of too much law? That is, state debt crises might be symptomatic of a deeper crisis whereby the state fiscal policy-making process is gummed up by statutory and constitutional restrictions on the use of public resources, such that combating budgetary shortfalls - whether caused by economic recession, political gridlock, or some combination of the two - becomes increasingly unlikely.

In the states that allow them, constitutional amendments by direct democracy - whether by popular initiative or by legislature-approved referendum - can place unyielding restrictions on the state budgets which, in times of crisis, may render the state unable to meet its fiscal demands. Add this problematic dynamic to the frequently dysfunctional fiscal policy processes so often associated with these same states’ legislatures and the result can be fiscal deadlock, and potentially, fiscal crisis. In a federal system as exists in the United States, these state fiscal crises can quickly create moral hazard, as states take risks that they hope the federal government will absorb. If the federal government agrees, federal taxpayers would thus absorb the losses of state fiscal crises in a way that, if history is a guide, will distort political conversations regarding fiscal policy for a generation. These twin problems - the inherent instability of fiscal policy by constitutional amendment and the risk of moral hazard in a federalist system - are important and understudied dynamics of state fiscal crises.

This symposium essay offers a preliminary, counter-intuitive solution to these problems: use direct democracy to combat direct democracy, and thereby provide protection to federal taxpayers exposed to losses by state fiscal crises. Taking a cue from the Financial Review Board system seen in the municipal bankruptcy context, the essay proposes a state constitutional amendment by referendum or initiative that dislodges the fiscal policy-making process from the legislature and referendum-burdened state constitution. In place of these traditional fiscal policy-making regimes, the referendum would accept the authority of a federally created commission, what this essay calls the Fiscal Restoration Commission (FRC). The FRC would then recreate the state’s budgetary laws from the ground up. The release of federal funds to save a state’s fiscal affairs would be contingent on the adoption, again by referendum, of the Commission’s proposals. The result is thus a clearing of restrictive law, rather than the clearing of restrictive debt, the mechanism that characterizes most state restructuring proposals.

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