Why is Fed. bail out a bad idea?  A conflict has emerged between states that have pursued prudent fiscal policies versus those that have been profligate in their spending, accumulating crippling amounts of debt. While the danger of this disparity has not yet captured public attention, the “silent bailout” of these fiscally irresponsible states by the federal government is unsustainable and will eventually lead to default and bankruptcy.

Silent bailouts entail the allocation of federal tax dollars to reckless states to help them meet their unrealistic spending obligations. This transfer shifts the debt burden of those states onto their responsible, wealth-creating neighbors.

For instance, Kansas, Oklahoma, Nebraska and some other ‘heartland’ states that have adopted fiscal policies to restrain growth in spending have been able to keep their budgets in check and, therefore, propose or enact cuts in their income taxes. In contrast profligate states, such as California and Illinois, have failed to reduce the growth in their own spending and continue to face sizeable deficits and accumulate debt.

Lawmakers in California and Illinois have proposed tax increases to offset revenue shortfalls. But rather than pay down existing debt, they use the increased revenue to fund additional government spending.

Higher tax states discourage long-term economic growth compared to lower tax states. Because they require more money to meet their more expensive budgets, they have become increasingly dependent on federal transfers. Much of that federal money is used to fund entitlement programs such as Medicaid, which allows states to get more than a dollar in federal money for every dollar they spend. Federal transfers to state and local governments more than doubled since 2000. This silent bailout accelerated with the 2009 American Recovery and Reinvestment Act (ARRA), which allocated $144 billion to state and local governments—a disproportionate amount going to spending-heavy states.

Though these bailouts may have been well-intentioned policies aimed to help states avoid tax increases or politically difficult decisions on where to cut excessive government spending, the bailouts have eliminated incentives to act responsibly and balance budgets. Instead, bailouts have actively encouraged continued spending. In fact, profligate states have a history of expanding entitlement programs in order to maximize federal matching funds for these programs.  Even as revenues dropped, spending went up in a majority of states during the start of the economic downturn.

As profligate states become more dependent on federal transfers, the debts incurred by them are effectively shifted to prudent ones while taxpayer money from prudent states disproportionately goes to federal spending in the profligate states. By rewarding spenders and punishing savers, the federal government creates all the wrong incentives for state fiscal policy.

Consider pension funds. There is a high probability that state pension funds will not be able to meet their massive, growing obligations. When that occurs, states such as California and Illinois—which have already accumulated hundreds of billions of dollars in debt in their retiree pension and health care programs—will not be able to bailout  these failed plans. These states will likely demand a federal bailout of their state pension plans, similar to the federal trust fund established to bailout failed private pension plans.

These kinds of policies have dangerous repercussions for the United States as a whole. A significant share of the deficits and debt accumulating at the federal level are linked to transfers to state and local governments. We’ve witnessed this before in other major debtor countries. Much of the fiscal instability in Argentina and Spain is linked to deficits and debt incurred by their regional governments.

If our own silent bailout continues to grow over the next business cycle, we should expect further challenges to the credit worthiness of the federal government. In fact, the Congressional Budget Office (CBO) predicts that, at this rate, by 2022 U.S. national debt will reach 90 percent of our GDP. State and local governments have accumulated $2.4 trillion in debt, or more than 15 percent of GDP, and face their own fiscal crisis with credits downgrades and municipal bankruptcies.

The silent bailout is accelerating in America and moving us closer to the fiscal crises encountered in other major debtor countries. There is no greater threat to our economic freedom than the fiscal profligacy engendered by the silent bailouts encouraging greater and greater debt.

By Barry W. Poulson, Professor Emeritus, University of Colorado Boulder; Past Commissioner to Colorado Tax Commission