By Kate Davidson
WASHINGTON -- A last-minute provision added to the $1.9 trillion
coronavirus relief package last month is leading to a showdown
between states and the Treasury Department over the limits of the
federal government's fiscal authority.
The package, known as the American Rescue Plan, provided $195
billion for state governments to help offset soaring costs related
to the pandemic and plug budget holes stemming from the economic
downturn. Democrats added one important condition: States cannot
use the money, directly or indirectly, to cut taxes.
Republican lawmakers and attorneys general argued the provision,
which would apply for three years, is overly vague,
unconstitutional and would unfairly penalize states in good fiscal
health. Five states have filed lawsuits seeking an injunction
against the provision -- the first hearing is scheduled for the end
of the month -- and Republicans in Congress have introduced
legislation to repeal it.
Meanwhile, state officials and tax-policy experts are pressing
Treasury Secretary Janet Yellen to clarify how broadly her agency
will interpret the legislation, and what will happen to states that
run afoul of the law. The need for guidance is urgent for many
states that must complete their budgets before the fiscal year
begins on July 1.
"It is potentially a significant restriction on state fiscal
authority, and some of that may come down to the Treasury
guidance," said Jared Walczak, vice president of state projects at
the conservative-leaning Tax Foundation. "If this became a broad
restriction, that raises serious constitutional questions."
As the virus began to spread last year, widespread lockdowns
triggered business closures and millions of layoffs that weighed on
state tax revenue, while spending on jobless benefits, healthcare
and other social services rose.
But not all states experienced the revenue shortfalls that most
initially feared. About half have seen tax collection increase,
thanks in part to the strength of the housing and stock markets,
which boosted property and income-tax revenues, and a surge of
federal aid such as stimulus checks and enhanced jobless benefits
that propped up consumer spending.
Some states with strong revenues, including Idaho, Utah, Arizona
and North Carolina, are weighing tax cuts for the coming fiscal
year. Those plans are now complicated by the American Rescue Plan,
which says any state that accepts the federal aid may not use it
"to either directly or indirectly offset a reduction in the net tax
revenue" of that state. Some states argue that provision interferes
with their right to set their own fiscal policy.
One issue is how the federal government defines "indirectly." If
states use federal aid to pay teachers and firefighters, for
example, then use the savings to lower taxes, that could be
considered an indirect tax cut, Mr. Walczak said.
It is unclear how far that logic would extend. Among the
questions states have asked: Would policy changes, such as new tax
incentives for businesses, be considered indirect tax cuts?
West Virginia's Legislature is considering a bill that would
extend a tax credit for charitable donations to nonprofit
organizations and increase the annual cap from $3 million to $5
million -- a change that would reduce state revenues.
"To this point, we have been very dissatisfied with Treasury's
response" to questions, West Virginia Attorney General Patrick
Morrisey said in a statement. He outlined his concerns in a letter
last month with 20 other state attorneys general.
Mr. Morrisey has filed a joint lawsuit with several other state
attorneys general in federal court in Alabama seeking to block the
provision.
"West Virginia is a sovereign state with the power to
independently reduce its citizens' tax burden and decide how
taxpayer funds are spent, " he said.
In a response last month to the letter from the attorneys
general, Ms. Yellen said nothing in the act prevents states from
enacting "a broad variety of tax cuts." Rather, it says the federal
aid money cannot be used to offset a reduction in net tax revenue,
she said in a March 23 letter. If states cut taxes but find another
way to replace the lost revenue, that wouldn't violate the
provision, she said.
But Ms. Yellen has acknowledged that defining what it means to
use the aid as a revenue offset is tricky. "Given the fungibility
of money, it's a hard question to answer," she told the Senate
Banking Committee on March 24.
The Treasury last week clarified that states that take steps to
conform with federal tax-law changes -- including recently enacted
tax relief for unemployed workers -- won't be considered to have
violated the prohibition on tax reduction. Ms. Yellen has said the
Treasury is working quickly to provide additional guidance.
Phil Berger, the GOP leader of the North Carolina state Senate,
said he has no concerns, based on Ms. Yellen's March 23 letter,
that tax cuts proposed by Republican state lawmakers will run into
problems under the new federal law. North Carolina Republicans want
to reduce the personal income-tax rate, increase the amount of
income not subject to taxes and increase the child tax credit. The
state's tax revenues have risen between 2.5% and 5% since the start
of the pandemic, according to data from the Urban Institute.
"We fully have the capacity to reduce taxes in the way that we
have proposed," Mr. Berger said, "and will not have to rely on the
federal dollars in order to do it."
Tax-policy experts and congressional Republicans want more
certainty. Sens. Mike Crapo (R., Idaho) and Mike Braun (R., Ind.),
and Reps. Kevin Brady (R., Texas) and Dan Bishop (R., N.C.), have
each introduced separate measures in Congress to overturn the
language.
Joe Bishop-Henchman, vice president of tax policy and litigation
at the National Taxpayers Union Foundation, said the Treasury
guidance should make clear what baseline the agency will use to
determine whether there has been a net reduction in tax revenue and
who will make the determination. The foundation is a nonprofit
research group affiliated with a conservative organization.
Mr. Bishop-Henchman also called on Ms. Yellen to clarify that
state tax-law changes announced or enacted before the American
Rescue Plan was passed won't be subject to the provision and to
specify what action the Treasury will take if it finds a state has
violated the provision.
"If they do all the things we recommend in the letter, I think
everyone will be happy with it, but it may not change the fact that
this provision probably exceeds what Congress can constitutionally
do," he said. "And Treasury cannot do anything about that."
Write to Kate Davidson at kate.davidson@wsj.com
(END) Dow Jones Newswires
April 14, 2021 05:44 ET (09:44 GMT)
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