The American Rescue Plan provision to limit the amount of tax reduction states can engage in if they receive federal funding is being challenged in a number of lawsuits.
On the one hand, the legislation provides funding for states and localities, but it also restricts the use of funding, according to Jeff Friedman, partner at Eversheds Sutherland and leader of the tax practice group.
“The provision aims to not fund tax reduction at the state and local level,” he said. “The policy behind this is that the federal government will provide funding for the extra costs due to COVID, but they don’t want the states to use federal funds to pay for tax decreases.”
Treasury guidance appears to be favorable for states, according to Friedman, in that it provides a safe harbor for states to issue tax relief if the relief is not more than 1% of a state’s 2019 reporting year’s total revenue. Friedman indicated that the 150-page guidance complicates matters for states and localities, since they may misinterpret it or miscalculate a tax change.
“This guidance is very complicated and forces debates for all states because they must consider all their tax revenues every time they consider a tax reduction,” he said. “The safe harbor with 2019 as a base year is challenging to calculate.”
Even if revenue collected is above the 2019 base year, it might be a reflection of a growing economy — for example, higher property values, more transactions generating sales tax or more economic activity in general, Friedman observed. “If a state cuts the corporate tax rate but at the same time is collecting more tax revenue this year than in 2019, does that bring it within the safe harbor?” he asked. “That scenario is quite likely because the economy is strong, people are going back to work, and corporate profits are up.”
A number of states have filed lawsuits against the federal government claiming that the prohibition on state tax cuts violates the Constitution. “Most of these lawsuits have been filed by Republican attorney generals in red states,” said Friedman. “They claim that it is an unconstitutional intrusion into state policymaking by putting such significant strings attached to federal funding.”
The notion of the federal government giving funds to states with strings attached is not new, Friedman observed. “The 55-miles-per-hour speed limit was passed in a number of states because they would only get federal funding if they agreed to not having a speed limit higher than that. Now the federal government is saying that they want to provide additional funding because of COVID but the state can’t use the money to fund tax cuts.”
The state suits are saying that this is a different kind of restriction than what they had to deal with in prior instances, according to Friedman. “They claim that this is so intrusive that it violates the Constitution. They’ve been answered by procedural motions by the federal government saying that these cases are premature.”
The New Civil Liberties Alliance has filed amicus briefs in cases filed by Ohio and West Virginia against the Treasury, arguing that the conditions of the provisions of the tax cut prohibition are ambiguous and overly broad. “Further, the power of the state governments to tax or not to tax is a core attribute of state sovereignty. Congress cannot coerce states into surrendering taxing powers, especially with a heavy-handed offer-a state-can’t-refuse for federal pandemic relief funds,” it stated.
“The tax cut ban is a constitutionally prohibited condition on spending,” said Peggy Little, senior litigation counsel at the NCLA. “Congress has delegated powers to the Treasury that it could never enact in a statute — essentially the right to serve as dictator, arbiter, auditor and adjudicator of state fiscal and tax policy. The tax cut ban’s provisions offend state sovereignty, federalism and anti-commandeering principles, the Constitution’s guarantee of a republican form of government and the Tenth Amendment, and it should be declared unconstitutional for these reasons.”
