The moral case for letting Connecticut go under

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Amidst growing concern over the shaky financial conditions of California, Illinois, and New Jersey, my home state of Connecticut is often overlooked. Its size and population are relatively small, and its position between Manhattan and Boston make the state appear unimportant. Moreover, with some of the nation’s wealthiest communities — Darien, New Canaan, and Greenwich — how bad could things really be?

Very bad, according to a 2016 study for the Mercatus Center at George Mason University. The study calculated the fiscal health of each state according to its short- and long-term debt, unfunded pensions, and other key fiscal obligations. Connecticut came in the sickest of all.

Over the last month, all three of Wall Street’s big credit rating agencies have further downgraded the state’s debt, with Fitch and Moody’s ranking Connecticut’s fiscal soundness as the third worst in the country. S&P was only a little more generous, naming the state fourth worst behind Kentucky.

But that’s not all. Tax receipts in Connecticut over the next two years are expected drop 12–14 percent below what was originally budgeted. Last summer Superior Court Judge Thomas Moukawsher declared that the state’s public school system must be completely revamped to benefit urban and learning disabled students. And the state legislature remains reluctant to raise already high income and corporate taxes in the wake of General Electric’s protest move to Massachusetts. Add that all up and Connecticut is arguably the most financially distressed state in America.

Unsurprisingly, the two major parties are suggesting very different solutions. Democrats want to eliminate a popular $200 property tax credit; tap the state’s rainy-day fund; grant permission for a third casino complex; legalize marijuana; tax non-profit hospital properties; put up highway tolls; and ask the public employee unions for modest pay and benefit concessions.

Republicans, meanwhile, want much larger concessions from the unions; a clampdown on overtime rules; and the consolidation or privatization of public services. A February proposal by the state’s Democratic governor, Dannel Malloy, to bill towns for a third of the state’s obligation to the teacher pension fund has so far been resisted by both parties.

About the only policy lawmakers do seem to agree on is that the Nutmeg State should not be allowed to go bankrupt. More accurately, they all agree that nothing should be done to frighten bondholders so much that a bankruptcy option, which is not addressed in current federal law, would have to be invented (as it was last year for Puerto Rico).

It’s easy to see why politicians from both parties would want to avoid the kind of financial black eye that would make it harder to borrow money in the future. Yet, from a national perspective, if you had to let one state go as a warning to the other 49 to finally get their own financial houses in order, Connecticut would be the ideal choice.

Not only are we a small state, we also have no county governments to be unfairly tainted by their association with a deadbeat legislature. The map line separating, say, Tolland County and Windham County means little more than the line itself. Going down to the municipal level, the overwhelming majority of Connecticut’s 169 towns are in decent financial shape and so are unlikely be harmed by the legislature’s tarnished reputation.

As for Connecticut’s most distressed cities, Hartford and Bridgeport, the finances of the former are so bad that its bankruptcy is a virtual certainty, regardless of the fate of the state’s finances overall. In early May, Mayor Luke Bronin confirmed that Hartford has already solicited proposals from law firms specializing in Chapter 9 protection for municipalities.

Similarly, Bridgeport, which was barely prevented from declaring insolvency in 1991 by a state review board, would gain little from keeping the legislature’s budget on life support. If anything, Connecticut’s bankruptcy would begin to correct problems that for decades have prevented its older industrial cities from spontaneously regenerating: heavy spending on health insurance for retired city workers (almost completely phased out of the state’s private companies); antiquated binding arbitration laws; and a general lack of fiscal discipline.

When one thinks of the two constituencies that would be most harmed by a state bankruptcy — its bondholders and its public employee unions — there is a certain justice to letting Connecticut be the chastened example for the rest of the country.

In theory, municipal bondholders play a crucial role in promoting the fiscal health of states and municipalities by adjusting the interest rates they demand for lending their money. But for decades, affluent investors across the U.S. have largely ignored mounting civil debt, underfunded pensions liabilities, and other telltale signs of local government distress on the assumption that Washington would, if necessary, bail them out.

Such magical thinking is perhaps understandable in Mississippi, Wyoming, or some other state with no major financial industry. But Connecticut is the third largest hedge fund capitol in the world after New York City and London. A good portion of its most affluent and influential citizens make their livings at banks, brokerage houses, and trust companies headquartered in Manhattan. Any blindness in Connecticut to the frailty of its finances is as close as one can get to a state version of the 2009 subprime real estate crisis.

As for Connecticut’s public employee unions, their campaign contributions have so corrupted state legislation that towns are almost helpless to control worker salaries and benefits. There is, in fact, a statute — the “minimum budget requirement” — which prohibits most school districts from reducing their spending whenever the student census drops.

Little more than a quarter century ago, Connecticut was widely known as “the Switzerland of New England.” There was no state income tax, and corporations in nearby New York happily crossed the border to establish headquarters in Stamford. Today, in the aftermath of a union-dominated legislature and an absence of rigorous bondholder oversight, the U.S. Census Bureau shows Connecticut losing population at an accelerating rate. If any state must go under as a lesson to all the others, let it be the one that can not only tolerate it best, but also deserves it most.

Lewis Andrews was executive director of the Yankee Institute for Public Policy from 1999 to 2009. He is the author of To Thine Own Self Be True: the Relationship between Spiritual Values and Emotional Health (Doubleday).

This commentary first appeared in Real Clear Policy on May 26, 2017.

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