States Should Still Be Prepared to Borrow

The pandemic has blown huge holes in most state budgets.  Now, with the advent of the Biden Administration and a Democratic Congress, there is a reasonable chance that substantial federal aid is coming – finally.

Given this turn of events, states may conclude that it no longer makes sense to borrow to handle budget shortfalls.  This would be a mistake.  The new round of relief has not yet passed, and it is unclear whether it will be sufficient either in general or as to particular states.  It is also unclear whether it will be enough as the crisis unfolds.  States have already made sweeping cuts – and made insufficient investments in vital tools to handle the pandemic – while waiting for more federal aid since the spring.  They should not repeat that mistake.

Rather than cut services – and in the absence of appropriate federal support – it would be better for states to raise taxes from those who can afford to pay.   Yet raising taxes takes time and, in most cases (but not all), will not raise enough revenue in the short term.  However, if a state were to raise taxes and then securitize some of that revenue, the money raised for immediate needs could be substantial.

It is a common belief that states cannot borrow, which would mean that it does not matter whether one accepts our policy argument.  Yet in some states, either amending the state constitution or putting a constitutionally authorized borrowing proposal on the ballot, for voters to approve, is not that difficult.

But even without a constitutional change or an election, the kind of borrowing we propose is (likely) possible under one of several longstanding exceptions to the requirement that borrowing requires an election under state constitutional law.   We will focus on one exception here (for more of the argument see here): the special fund exception. Under this exception, if all that investors are promised is a specific stream of revenue – and no more – then such borrowings are not considered to trigger the election requirement or other state constitutional bars against deficit spending because the general taxing power of the government is not being promised.

It could be objected that the states could not get a good deal if they put together such borrowings.  We don’t think the data bear this out.  For instance, the New Jersey Constitution permits the state to borrow during an emergency.  Accordingly, the governor proposed, and the legislature approved, borrowing up to $9.9 billion.  The first $4 billion in bonds were priced at the end of November 2020; they will cost New Jersey less than 2 percent in annual interest over a 10-year term.

The Fed Can Still Help

Ideally, the states would not need to access the regular municipal market.  The best thing would be for the new relief plan to contain an explicit provision that would permit making loans to states and localities at the federal government’s cost of funds, subject to guardrails.  Note that legislation to this end is not absolutely necessary, though clearly preferable and appropriate given the general uncertainty about the duration of the crisis and the likelihood of specific jurisdictions needing much more help than others – and needing that help later.

The Consolidated Appropriations Act of 2021 (Section 1006) explicitly did not take away any preexisting authority of the Federal Reserve.  Thus, in coordination with the U.S. Secretary of Treasury, under Section 13(3) of the Federal Reserve Act, the Fed can make loans to the states.  Indeed, under Section 14 of the Federal Reserve Act, the Fed could have acted without agreement of the secretary of the Treasury, though that is not likely a problem any longer.

Just as any legislation should contain rules limiting any state or local borrowing, the Fed could and should develop upfront limits on the amount of debt it would be willing to extend or purchase from a state or locality based on the size of the projected state or local deficits compared with a recent historical baseline (and taking into account federal aid).  This seems a reasonable safeguard, as a matter of both politics and fiscal federalism.


It would be ideal if the federal government could be counted on to act promptly and sufficiently in the face of a national financial crisis.  This is the second time in the 21st century that this has not happened.  The states should be preparing to borrow so they have the resources needed to deal with the current crisis over the next several years.  They should also be considering how to formalize emergency borrowing mechanisms so that they are available the next time.

This post comes to us from professors Darien Shanske at the University of California, Davis – School of Law and David Gamage at Indiana University Maurer School of Law. It is based on their recent article, “The Case for State Borrowing as a Response to the Current Crisis,” available here.