With all the headlines about billionaires fleeing California because of a proposed — and self-harming — wealth tax, our disastrous state budget has escaped the grim headlines it merits. As Gov. Gavin Newsom prepares his 2028 presidential run, he leaves California in a precarious financial position. We are stuck in a spiral of structural deficits that new tax revenue cannot fix.
But bankruptcy can. It’s a feasible, albeit long-shot, solution that offers the state a chance to halt its budget meltdown — something California’s current political leadership has not had the courage to do.
Spending under Newsom has exploded (opens in new tab). In Jerry Brown’s last year as governor, the state’s general fund spent $142 billion (opens in new tab). This year, Newsom proposes to spend 75% (opens in new tab) more. Even though tax revenues have soared from a stock market that has nearly tripled since he took office, Newsom has chosen to run deficits. He has financed those deficits with borrowings, deferred payments, and budget reserves to the point that his own multiyear forecast predicts budget reserves turning negative (opens in new tab) after the next governor takes office.
The California Legislative Analyst’s Office (opens in new tab) confirms this dire state of affairs, forecasting annual deficits of between $20 billion and $35 billion and warning that “deficits have persisted even as the state’s economy and revenues have grown, underscoring that the problem is structural rather than cyclical. Taken together, these trends raise serious concerns about the state’s fiscal sustainability.”
Some observers, such as Elon Musk, have suggested (opens in new tab) that California is on the path to bankruptcy, but under current federal law, states cannot declare bankruptcy. Changing this would require an act of Congress, not a state ballot measure. Federal legislators would need to amend Chapter 9 of the U.S. Bankruptcy Code, which applies only to municipalities, to extend that same orderly restructuring power to states. Legal scholars like University of Pennsylvania professor David Skeel have championed this (opens in new tab) at the American Enterprise Institute, arguing that it is constitutional provided the process is voluntary.
While there is no bill on the floor, the political will for such a move exists at the highest levels. In 2020, then-Senate Majority Leader Mitch McConnell explicitly suggested (opens in new tab) allowing states to use the “bankruptcy route” rather than asking federal taxpayers to bail out mismanagement. Even President Donald Trump signaled openness to the idea, posting (opens in new tab) on social media that he was “open to discussing anything” that avoided bailing out “poorly run states.” And in our current political environment, seemingly farfetched ideas have a track record of gaining momentum quickly.
It would be a good thing if states could do so. While bankruptcy sounds alarming, it’s a relief for residents when funds are no longer shifted from services to creditors. That’s how Detroit got back on its feet (opens in new tab). By declaring bankruptcy in 2013, Detroit won breathing space to serve residents while putting its affairs in order. California could do the same.
The principal creditors of local and state governments are Wall Street and public-sector unions, both of which encourage governments to issue obligations they hope can never be canceled. Wall Street banks encourage cities to issue bonds (opens in new tab), while unions encourage obligations for pensions (opens in new tab) and other post-employment benefits (opens in new tab). When the issuing governments don’t set aside money to pay off those bonds and obligations as they come due, the burden falls on later governments. To get the money, those governments cut spending on services.
If a government cannot declare bankruptcy, then money keeps flowing to creditors, services get decimated, and even higher taxes don’t do anything other than maintain current levels of government support. This amounts to a direct transfer from taxpayers into the pockets of state employees and Wall Street financiers.
You can see this creditor-led destruction all over California. Stockton’s bankruptcy was in large part the result of $300 million of bonds issued to banks. Even when there aren’t deficits, obligations to creditors bleed programs. This year, the Los Angeles Unified School District is spending $3.15 billion on debt service and retired employees, leaving too little for current employees. Students at the University of California and California State University are paying more in tuition and getting fewer services in part because the state doubled (opens in new tab) its annual retirement spending over the last decade. To add insult to injury, the politicians who approve these obligations have often received political support (opens in new tab) from the beneficiaries of the obligations.
To be clear, bankruptcy is a tool of last resort that Wall Street and public-sector unions would fight with every dollar they have. But as it stands, California has no leverage over these perpetual creditors. The mere option of bankruptcy would end the “hold-out problem” in which creditors refuse to negotiate, forcing the reforms California desperately needs.
Absent liberation from Wall Street and public-sector unions, California faces a bleak fiscal future of declining services even amid rising revenues. Taxpayers and residents need a break. Congress and the president can provide one by allowing states to declare bankruptcy.
David Crane is a lecturer in public policy at Stanford University and president of Govern for California (opens in new tab).