Skip to content

The Bondholders’ Veto: Fiscal Federalism and Local Democracy


Brian Highsmith (@bd_highsmith) is an academic fellow in law and political economy at Harvard Law School and a Ph.D. candidate in government and social policy at Harvard University.

This post continues a joint symposium with our comrades at Just Money on Destin Jenkins’s The Bonds of Inequality. Expect new posts in this series to appear on Thursdays throughout the late summer and early fall.


In The Bonds of Inequality, Destin Jenkins documents the consequences of American cities’ structural dependence on the municipal bond market. He describes how collective decisions about local public investments came to be channeled through an elite collective of distant white financiers, who asserted their influence to entrench racial hierarchy. Although the focus of his book is on the effects of this pernicious institutional arrangement, Jenkins also sketches an account of its origin.

Jenkins’ account helps us develop a fairly clear story about the relationship between democracy and our fiscal federalism design, which places on local communities the primary responsibility for funding critical public goods. The bondholders’ veto derives from cities’ reliance on debt, which in turn is created by the absence of redistributive transfers across geography. In this way, the municipal bond market is but one example of a general dynamic that results from the interplay between jurisdictional fragmentation, local fiscal responsibility, and racialized economic inequality. American cities’ structural reliance on municipal debt might be understood as part of a larger structural reliance on concentrated, mobile capital that is a consequence of our comparatively unique system of fiscal federalism. 

The democratic consequences of this arrangement can be observed in Jenkins’ narrative when cities, navigating dire fiscal straits, consistently held their debt obligations to be sacrosanct “because bondholder power was of greater concern to municipal officials than the outrage of ordinary residents.” But these same dynamics are implicated when the most valuable public company in the world escapes local taxation by leveraging the threat of exit to defeat a popular initiative to address chronic housing instability. Or when a Republican governor offers to a foreign multinational, as part of a $3 billion enticement package, a unique and unprecedented right to appeal any unfavorable decision directly to the state’s GOP-controlled Supreme Court. Or when Chicago opts to outsource its parking enforcement authority to a group of private investors, under terms restricting—for the next 75 years—the city’s ability to manage its urban design and requiring a vast, costly supply of on-street parking. 

Each of these antidemocratic outcomes should be understood, at least in significant part, as a downstream consequence of the economic capture that results from our decision to block redistribution across geographic space. Under our fiscal federalism design, local public goods are funded predominantly from wealth contained within constructed and contested municipal boundaries. This design is not inevitable: even other systems characterized by political and programmatic decentralization feature considerably higher inter-jurisdictional redistribution, typically through centralized fiscal transfers. One group of researchers recently noted “how distinctive the United States is in the way it combines institutional arrangements that facilitate metropolitan fragmentation (through jurisdictional proliferation) and those that reward such fragmentation (through opportunities for resource hoarding).” 

Overlaid on top of patterns of racial and economic segregation, this design creates particularly acute fiscal pressures in oppressed communities. As Margaret Weir and Desmond King have put it, “Greater degrees of local governmental fragmentation promote inequality by allowing more affluent residents to choose the level of services and taxes they wish to pay for, while less affluent residents may remain trapped in jurisdictions with weak tax bases and poor services.” Through mechanisms I have described as “municipal hoarding,” cities’ boundaries come to function effectively as tax shelters for white residents of segregated neighborhoods. Accumulated wealth that has passed down across generations—over decades in which families of color were systematically excluded from economic opportunity—is thus shielded from the democratic demands of neighboring families. 

Under a system that restricts fiscal transfers across jurisdictions, devolution may be inevitably associated with a structural reliance on market-like mechanisms for public goods provision. Consider public investment possibilities in a municipality that lacks significant taxable wealth within its jurisdiction. Absent centralized transfers, such places have limited options: they can either underinvest in local public goods, or seek to provide them without taxing wealth. The latter can be done through regressive charges on their current populations (as through user fees) or by borrowing from the future (as through public debt). Even where the state itself avoids credit markets, the charges it imposes in their place will tend to become debt at the individual level, as poor families who lack the means to make immediate payment then turn to credit

The democratic implications are clear: even if the members of this municipality unanimously desire to fund public investments like schools through progressive taxes on wealth, they cannot do so. When wealth concentrates in fortified white alcoves, and unconditional centralized transfers are withheld, neighborhoods targeted by racialized oppression and spatial neglect have little choice but to “bribe” in the capital that is required to make local investments—relinquishing, in the process, democratic control.  Indeed, American cities’ structural dependence on the municipal bond market is not unlike the wage dependency that allows American employers to exercise domination over their workers. The comparison allows us to see how both forms of domination are contingent on the organization of our political economy. For cities and workers alike, commodification results from the absence of redistributive transfers provided through the state—thus ensuring that risks are individualized while gains are hoarded. 

The analogy extends even more directly. The cavernous gaps that characterize our individual-level social safety net do not only drive American workers into unsafe and underpaid employment: they also drive them into debt. This is not merely an American phenomenon: as Andreas Wiedemann recently summarized, “A growing body of work associates higher debt levels with limited welfare states, suggesting that the former can substitute for the latter.” But as Chloe Thurston has documented, the United States’ political economy is uniquely characterized by its “enlist[ing] market mechanisms to fulfil the goals of social policy, including protection against risk, meeting basic needs, and securing opportunity for mobility.” Jenkins’ account helps us extend these frameworks, by incorporating public debt—and demonstrating that the relationship between state withdrawal, reliance on market mechanisms, and antidemocratic subordination can be fruitfully generalized across contexts.

Doing social policy through credit scores has predictable effects: after all, capital tends to chase returns, rather than majoritarian preferences. And so a central characteristic of this structural reliance on market mechanisms, including various forms of public and private debt, is to undermine democratic control. In Jenkins’ book, this happens through the bondholders’ veto—but it would also include, for example, the leverage used by dominant firms to extract public subsidies and regulatory favors from economically precarious cities, or that wealthy white homeowners deploy when they threaten to flee to the suburbs. Our system of fiscal federalism impedes social democracy by guaranteeing holders of private wealth—by virtue of their wealth—a veto over the democratic use of public money. As Eleni Schirmer put it last month, “Creditors and credit rating agencies loom over public institutions like shadow governance systems.”

It is striking, then, that this anomalous feature of our institutional design is so often defended in democratic terms—as allowing sorting according to preferences for public goods and protecting the sacrosanct virtue of local control. This apparent irony can be resolved by seeing clearly, as the LPE framework helps us do, what is unstated in many such accounts: that preferences can be weighted by wealth, and “democracy” understood as what allows wealth holders to act without regard for the collective will. Seen in this light, the underfunded public schools in poor communities reflect not the satisfaction of residents’ idiosyncratic preferences, as implied by classic accounts, but rather the triumph of markets over political equality and an inclusive democracy.

At one point Jenkins recounts how San Francisco mayor George Moscone, preparing his constituents for the “difficult times” that lay ahead, assured them that there was no “pot of gold, a secret cupboard, or some budget gimmick which ‘makes it all work out.’” But of course, there is: the federal government, which—under a different system of fiscal federalism—could allow cities to make democratic investments with the immense wealth produced by our economy, no matter how it is distributed over geographic space. Doing so would reduce cities’ reliance not only on the municipal bond market, but also on all the various other mechanisms that similarly outsource democratic authority from the public to holders of mobile wealth.