A Note on Allowing State Bankruptcy

Minjie Deng

Discussion Papers from Department of Economics, Simon Fraser University

Abstract: U.S. states are sovereign entities and can’t declare bankruptcy as cities and municipalities. This paper examines the impact of a switch in sovereign bankruptcy rules that allows declaring bankruptcy from an economics model perspective. Allowing bankruptcy increases ex-ante risks for the government to refuse repayment, but provides ex-post benefits of reducing default costs and saving federal bailouts. This paper provides a simple framework to analyze this tradeoff. Whether allowing for bankruptcy increases or decreases borrowing costs depends on the level of income and borrowing for the government.

Date: 2024-10
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Journal Article: A note on allowing state bankruptcy (2025)
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