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Republicans Press for Guidance on State Tax Cut Restriction in COVID-19 Relief

Posted on Mar. 18, 2021

Republicans are pressing the Treasury Department to clarify a provision in the recently adopted federal COVID-19 law that could prevent states from using federal aid for corporate tax breaks and other tax relief. 

Republican attorneys general from 21 states sent a letter on March 16 to Treasury Secretary Janet Yellen requesting that Treasury quickly clarify that the law doesn’t prohibit states from using the aid to generally provide tax relief. Federal legislation (S. 743) has been introduced to remove the provision.

If guidance isn't issued by March 23, “we will take appropriate additional action to ensure that our States have the clarity and assurance necessary to provide for our citizens’ welfare through enacting and implementing sensible tax policies, including tax relief,” the attorneys general said.

The letter was signed by attorneys general from Alabama, Arizona, Arkansas, Florida, Georgia, Idaho, Indiana, Kansas, Kentucky, Louisiana, Mississippi, Missouri, Montana, Nebraska, Oklahoma, South Carolina, South Dakota, Texas, Utah, West Virginia, and Wyoming.

The $1.9 trillion American Rescue Plan Act of 2021 (P.L. 117-2), signed March 11, includes $350 billion in aid for state and local governments. Republicans opposed the aid, which Senate Minority Leader Mitch McConnellR-Ky., said amounted to a bailout for blue states. 

While states will be able to use the aid to cover budget deficits, the act contains a provision that restricts it from being used to “either directly or indirectly offset a reduction in the net tax revenue of such state or territory resulting from a change in law, regulation, or administrative interpretation during the covered period that reduces any tax (by providing for a reduction in a rate, a rebate, a deduction, a credit, or otherwise) or delays the imposition of any tax or tax increase.”

Some believe the provision could be interpreted to prevent states from creating new tax incentives or providing new tax incentives under existing programs.  

The act also forbids the aid from being deposited in pension funds, which have become depleted during the pandemic. 

In the letter, the attorneys general said the language regarding revenue reductions “could be read to deny states the ability to cut taxes in any manner whatsoever — even if they would have provided such tax relief with or without the prospect of COVID-19 relief funds.”

“Absent a more sensible interpretation from your department, this provision would amount to an unprecedented and unconstitutional intrusion on the separate sovereignty of the states through federal usurpation of essentially one half of the state’s fiscal ledgers (i.e., the revenue half),” the attorneys general said. “Indeed, such federal usurpation of state tax policy would represent the greatest attempted invasion of state sovereignty by Congress in the history of our Republic.”

The attorneys general said the act’s prohibition against offsetting reductions in state tax revenue “might have been intended merely to prohibit states from expressly taking COVID-19 relief funds and rolling them directly into a tax cut of a similar amount.”

“But its prohibition on 'indirectly' offsetting reductions in tax revenue, combined with the list of prohibited kinds of tax reductions (rate cuts, rebates, deductions, credits, or 'otherwise'), could also be read to prohibit tax cuts or relief of any stripe, even if wholly unrelated to and independent of the availability of relief funds,” they said. 

Katie Conner, spokesperson for the Arizona attorney general’s office, said the attorneys general are “prepared to use every tool at our disposal, including litigation, to ensure Arizona and other states can enact and implement sensible policies on behalf of hardworking taxpayers.”

Ohio Attorney General Dave Yost (R) filed a motion for preliminary injunction March 17 in the U.S. District Court for the Southern District of Ohio, seeking to block the provision’s enforcement, at least in Ohio. Yost argues that the provision exceeds the authority of Congress by requiring states to choose between accepting stimulus funds or keeping their sovereign authority to reduce taxes.

“The federal government should be encouraging states to innovate and grow business, not holding vital relief funding hostage to its preferred pro-tax policies,” Yost said in a release. “Slipping last-minute conditions into a plan meant to help people that instead handcuffs Ohio is why people don’t trust government. And it almost always leads to constitutional mischief.”

Nicholas Johnson of the Center on Budget and Policy Priorities has argued that the provision is sound policy and is helpful “since states were considering using the one-time federal aid for permanent tax cuts, setting themselves up for budget cuts in the future when the aid expires and state revenues remain depleted by tax cuts.”

Johnson said that although “some tax cut proponents are unhappy with this provision and are exaggerating its impact,” the act won’t prevent states from cutting taxes. “It says they can’t use federal dollars to do that, either directly or indirectly. If a state chooses to enact a net tax cut, it will forgo the equivalent amount of federal aid provided through the Act’s Coronavirus State Fiscal Recovery Fund,” he explained.

Sens. Mike Crapo, R-Idaho, and James E. Risch, R-Idaho, sponsors of S. 743, argued in a March 15 release that the provision would allow states to provide tax relief but only at a “punishable cost” and that it “serves no useful purpose, other than to convey the message that tax cuts are not favored by the federal government.”

“If a state like Idaho wants to provide tax relief in the interest of economic recovery, and to help people return to earning their livelihoods, the American Rescue Plan says it will be financially punished by the federal government,” Crapo said. “This infringes on states’ authority to design their own fiscal policies, and invites partisan politics into federal and state relations.”

Crapo, the ranking member on the Senate Finance Committee, sent a letter and a list of questions to Yellen about the state and local aid. 

One of the questions asks how Treasury will define “indirectly” offsetting a tax reduction and whether a state that had planned an income tax reduction before the law was passed will “be limited in any way from covering allowable expenses (e.g., broadband infrastructure, public safety payroll costs, etc.) from the fund.”

House Republicans also sent a letter to Yellen, explaining that they have serious concerns about the provision and requesting clarification and guidance. "We have heard from many stakeholders concerned about the breadth of this provision, which was included in the [bill] without the benefit of committee hearings, a legislative markup, or any input from stakeholders," the March 17 letter said. 

Treasury did not respond to a request for comment by press time. 

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