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Politics

Republicans have a plan to hurt blue states. It could backfire.

Catherine Rampell on

And if Congress successfully repeals the deductibility of state income taxes, these states' fiscal challenges could quickly become a series of major -- and possibly contagious -- fiscal crises.

States are under fiscal pressure for a few reasons. The Great Recession, though it began almost 10 years ago, left budgetary scars that have not yet healed.

The bigger problem is what lies ahead.

As Stanford Graduate School of Business professor Joshua D. Rauh has documented, many states and municipalities bear huge unfunded pension liabilities. They've tried to hide them using accounting gimmicks -- by assuming preposterously high returns on pension fund investments, for example -- but eventually these debts will catch up to them.

Already, several states have experienced painful credit downgrades. New Jersey bonds have been downgraded 11 times since January 2010. Illinois's debt is barely above "junk" status.

These problems may be largely of these states' own making. Especially in New Jersey, where Republican Gov. Chris Christie looked at the state's budget problems and curiously decided to cut taxes.

But that doesn't make solving these states' debt problems any easier -- especially under the tax regime that federal lawmakers are crafting.

"The elimination of SALT could have the effect of increasing pressure from taxpayers for states to reduce taxes," Rauh emailed me before the bill came out. "If creditors deduce the long-term impact of this, that could drive up borrowing spreads for states where this deduction is very valuable."

He added that the tax plan would likely "add further resistance and reduce willingness-to-pay when state and local governments propose future tax increases."

Which means these state and municipal fiscal problems can only get worse.

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