Treasury Secretary Janet Yellen has responded to concerns about a provision in the recently adopted federal COVID-19 relief law that Republicans believe could be interpreted to prevent states from reducing taxes.
In a March 23 letter to Arizona Attorney General Mark Brnovich (R) and a coalition of Republican attorneys general, Yellen said that “nothing in the act prevents states from enacting a broad variety of tax cuts.”
“That is, the act does not 'deny states the ability to cut taxes in any manner whatsoever.' It simply provides that funding received under the act may not be used to offset a reduction in net tax revenue resulting from certain changes in state law. If states lower certain taxes but do not use funds under the act to offset those cuts — for example, by replacing the lost revenue through other means — the limitation in the act is not implicated,” Yellen said.
Yellen also responded to concerns that the provision could be unconstitutional, saying it is “well established that Congress may place such reasonable conditions on how states may use federal funding.”
“Congress includes those sorts of reasonable funding conditions in legislation routinely, including with respect to funding for Medicaid, education, and highways. Here, the act provides a broad outlay of federal funds, and accordingly includes restrictions to ensure that those funds are properly applied. Earlier COVID-19 relief measures providing state funding also included restrictions that barred states from spending those funds on certain ineligible expenditures,” Yellen added.
The $1.9 trillion American Rescue Plan Act of 2021 (ARPA, P.L. 117-2), signed March 11, includes $350 billion in aid for state and local governments. But concerns have been raised over provisions in section 9901 of the act that restrict aid 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.”
Yellen sent the letter in response to a March 16 letter from the Republican attorneys general requesting the Department of the Treasury to “take immediate action to confirm that certain provisions of the American Rescue Plan Act do not attempt to strip states of their core sovereign authority to enact and implement basic tax policy.”
The letter is 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.
According to the attorneys general, the language “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.”
In response to Yellen’s letter, Georgia Attorney General Christopher M. Carr (R) told Tax Notes that “Treasury’s response signals that our coalition was right to fight this unprecedented attempt at federal takeover of state policy.”
“In the letter, Treasury provides some assurance and promises to more specifically address the issues we raised. We will be closely monitoring how they do this so that our ability to enact good tax measures, like those signed into law just this week to benefit Georgia families, is not compromised in any way,” Carr said.
Katie Conner, spokesperson for the Arizona attorney general’s office, said that “Secretary Yellen’s response raises more questions than answers. Her letter was ambiguous and failed to provide the assurances that states can craft their own tax policies and budgets without being stripped of federal relief funding. We must seek clarification from the court.”
During a March 24 Senate Banking, Housing, and Urban Affairs Committee hearing, Republican lawmakers pressed Yellen to quickly issue guidance on the provision. She declined to commit to issuing guidance ahead of the 60-day statutory guideline, emphasizing that numerous complex questions will need to be resolved.
But Sen. Mike Crapo, R-Idaho, said states need immediate clarity on the issue and pressed Yellen for a timeline on when Treasury would issue implementing guidance.
Yellen responded by noting that the act gives Treasury 60 days to distribute the state and local aid money. She said that while there are thorny questions that need to be resolved by the guidance, “we simply are going to have to craft guidance in that period of time.”
Crapo and Sen. James E. Risch, R-Idaho, sponsored federal legislation (S. 743) to remove the provision.
Crapo praised Yellen for indicating in her letter that she would lean toward being less restrictive. However, he said the letter doesn’t answer the question of what kind of actions would be deemed a direct or indirect offset.
Later in the hearing, Sen. Steve Daines, R-Mont., decried the act’s state tax cut restriction as an “astonishing level of meddling by Congress in state fiscal affairs,” although he echoed Crapo’s praise for Yellen’s response to the state attorneys general.
Crapo also posed a hypothetical scenario in which a state decides to conform to the act’s exclusion of some unemployment compensation from taxable income and asked whether that would be deemed an offset to a tax cut.
Yellen responded that several states have asked about that, but she declined to offer an opinion, saying only that Treasury is “examining that question carefully.”
In a March 24 letter, Stephen P. Kranz of McDermott Will & Emery asked Yellen for public guidance to be issued on the provision as soon as possible.
Kranz said the provision requires “that a state return relief funds to the federal government if the state uses the relief funds to finance tax reductions.”
“This provision brought the world of state and local tax policymaking to a grinding halt and causes irreversible damage as each day passes,” Kranz said, adding that “Legislatures, Governors, and tax administrators across the country are suddenly in an uncertain world where every tax change or adjustment being considered, no matter how innocuous or routine, carries the risk of a reduction to their state’s share of federal relief funding. If the Treasury Department interprets ARPA’s plain language broadly or fails to provide sufficient guidance, sub-national policymakers will live with this risk for the next three years. That is untenable.”
Reporter Jonathan Curry contributed to this story.