LOUISVILLE, Ky. (WAVE) - Federal law currently does not allow states to file for bankruptcy, but in an interview Wednesday with radio host Hugh Hewitt, Senate Majority Leader Mitch McConnell said he would favor changing the law rather than sending states and cities direct federal aid.
The comment sparked a backlash of criticism and questions about what would happen if states could be allowed to go bankrupt.
“It brings up a plethora of issues,” creditors’ rights attorney Mindy Sunderland said. “I think one of the more significant issues would be pension obligations the state has, and how those would be treated in the bankruptcy?”
A bankruptcy at the state level, for example, would conceivably rip Kentucky’s often bitter fight over how pensions are structured out of the legislature and into the hands of a judge, where the state’s creditors would have a lot to say about how tax dollars are spent.
“They may end up with significant modifications that were not planned for and were not intended simply because there is not enough money to go around,” bankruptcy attorney Charity Bird said. “That is what a bankruptcy is designed to assist with, to spread the money further or cut things that have to be cut unfortunately.”
Municipal bankruptcies are allowed by law, but remain rare. When they do happen, employees, pensioners and taxpayers are not immune to the impact. Paying more taxes would be a possibility as a state’s or city’s finances are reorganized.
“The state’s budget, is that going to be something that’s going to be controlled by the bankruptcy court and by the creditors?” Sunderland asked. "How are the bankruptcy plans, if a plan is required to be funded? Would that result in tax increases?”