Freedom in the 50 States

An Index of Personal and Economic Freedom

Government Debt

This category encompasses state and local debt, which can worsen credit ratings and increase yields paid on government bonds.
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Government Debt

The problem with state and local debt, above a modest level, is that it worsens credit ratings and increases yields paid on government bonds.1 Current interest payments are already included in the state taxation variable. The problem with additional interest paid because of default risk is that it does not provide any additional services, and therefore we do not imagine that any taxpayers can consent to it, unlike interest paid that reflects pure time preference.

Economists James Poterba and Kim Rueben give readily interpretable coefficient estimates for our purposes.2 They found that a percentage-point increase in state debt as a share of personal income is associated with roughly a 100-basis-point increase in bond yield. The annual value of the additional interest payments generated by this increase in interest rate on the debt is therefore −(0.01 × debt). Like state and local taxes, we adjust this figure for federal deductibility.

For debt, we use the latest fiscal year data from the Census Bureau (FY 2021).

Footnotes

1. James M. Poterba and Kim Rueben, “State Fiscal Institutions and the U.S. Municipal Bond Market,” in Fiscal Institutions and Fiscal Performance, ed. James M. Poterba (Chicago: University of Chicago Press, 1999), pp. 181–208; and Craig L. Johnson and Kenneth A. Kriz, “Fiscal Institutions, Credit Ratings, and Borrowing Costs,” Public Budgeting and Finance 25, no. 1 (2005): 84–103.

2. Poterba and Rueben, “State Fiscal Institutions and the U.S. Municipal Bond Market,” pp. 181–208.