Bankruptcy is Not an Option for States

California's budget troubles may be serious--Democratic Governor Jerry Brown has proposed $12 billion in spending cuts this year--but it's just one of many states struggling to make ends meet.

"Some states are in a perilous position and have answered by having... some spending reductions and some tax increases," former George W. Bush advisor Karl Rove told Fox News. "In Illinois, for example, I think it's a 70% increase in income tax for state taxpayers." Rove noted that the options to make ends meet are limited.

Tax hikes can only go so far before the taxpayers revolt, which is why some economy watchers worry about states coming to the federal government to seek a bailout.

Douglas Elliott of the Brookings Institution says, "no state or federal officials that I am aware of have pushed for this, but the pressures are so strong I think you'll hear more and more about this possibility over time."

Republican lawmakers have made clear this will not happen.

"Should taxpayers in Indiana who have paid their bills on time, who have done their job fiscally be bailing out Californians who haven't?" House Budget Committee Chairman Paul Ryan, R-Wisc., asks. "No. That's a moral hazard that we are not interested in creating."

But what could states do if they try all the alternatives and still can't pay their bills?

Former White House budget director Peter Orzag noted in a Financial Times column that, "contrary to what many pundits suggest, state governments cannot simply declare bankruptcy... It is thus difficult for states to default: they would generally have to stop paying employees before they stopped making debt payments."

Some away from Capitol Hill say the law should be changed to allow states to declare bankruptcy. But Rove says there no lawmakers are seriously considering such a measure and will not until states have exhausted all other possibilities. It's a "zero chance that Congress is going to - in my opinion - proactively pass a bankruptcy law for states absent some crisis from the states that prompts it unless and until we have a state that runs out of whatever tricks it's got up its sleeve [to] raise taxes, cut spending, postpone spending [or] use budget gimmicks to bridge the gap."

Rep. Lamar Smith, R-Texas, chairman of the House Judiciary Committee, says he'll hold a hearing in the next few weeks to look at the matter but not to fashion legislation. "While bankruptcy for states may seem like an attractive alternative to state bailouts, there are significant constitutional concerns that should be addressed by congressional hearings. There are also policy concerns," Smith said. He also expressed concern that a federal bailout would lead allow states to spend more money not in their treasuries.

Rove says talk bankruptcy makes it harder for states to borrow money because lenders fear they might never get paid back.