June 8, 2021
By Jacob Huebert

With states still feeling the economic damage done by the COVID-19 pandemic, President Joe Biden signed the “American Rescue Plan Act” to give states billions of federal dollars to help them recover. But there’s a catch: The Act effectively prohibits states that take the money from cutting taxes through 2024. That’s unconstitutional—and the Goldwater Institute is joining one legal challenge to it.

Congress can sometimes put conditions on grants to states, but it can’t take advantage of an emergency to coerce states into giving up control of such an important issue of state policy, and it can’t impose a condition on a grant that has nothing to do with the grant’s purpose. That’s why many state attorneys general have filed federal lawsuits challenging this “Tax Mandate”—and it’s why the Goldwater Institute has filed a brief supporting the state of Ohio’s challenge.

The Tax Mandate

A provision in the Act says that states cannot use federal grant money to “directly or indirectly offset” a loss of revenue resulting from a tax cut enacted between March 2021 and the end of 2024. If they do, the U.S. Secretary of the Treasury will take the federal money back, up to the amount of revenue the state lost. That appears to mean that states that cut taxes between now and 2024 will have to pay back some or all their grant money.

The Tax Mandate’s defenders say this is just to make sure states actually use federal money for COVID relief. But the Tax Mandate doesn’t actually do that. The Act lists four broad categories of things a state can spend federal grant money on. After states spend the money, they have to report how they spent it to the Treasury Secretary. If the Secretary determines that a state spent money on something that doesn’t fall into one of those categories, she can take that money back.

So if a state receives a grant of, say, $5 billion, it has to show that it spent $5 billion on things the Act allows. If some things it reports weren’t appropriate uses of the money, the Secretary can recoup that portion of the grant. That alone ensures that states spend their federal grants for the purposes Congress intended.

The Tax Mandate, on the other hand, does not help ensure that states spend their grant money properly. Instead, it focuses on whether a state indirectly used federal funds to offset revenue lost as a result of tax cuts. That might make sense if the Act were otherwise designed to deny federal money to states that could afford to pay for their own COVID relief (if they put other policy priorities aside). But the Act doesn’t do that.

In fact, the Act does nothing to prevent states from “indirectly” using federal money to subsidize spending on anything they want—no matter how wasteful, frivolous, or otherwise unrelated to COVID relief. So the Act and its Tax Mandate aren’t designed to protect against states “indirectly” using federal funds for unapproved purposes; they’re designed only to stop states from cutting taxes.

The True Purpose: Less Competition for High-Tax States

In fact, the Tax Mandate’s true purposes are to impose a pro-tax political philosophy on states that would otherwise reject it and to stifle tax competition among the states. The Tax Mandate was inserted into the Act at the last minute at the behest of West Virginia Senator Joe Manchin, who says that “states shouldn’t be cutting taxes.” Manchin reportedly insisted on the provision to thwart a plan by the Governor of West Virginia (an office Manchin previously held) to phase out the state’s income tax.

And although some of its defenders suggest that the Tax Mandate exists to prevent states from opportunistically taking advantage of federal funds to enact new state tax cuts, the mandate also threatens state plans for tax reform that predate the Act—and not just in West Virginia. In Arizona, for example, Governor Doug Ducey’s proposed budget—issued well before the Act’s passage—called for income tax cuts. The Tax Mandate now threatens to punish Arizona if it follows through on Ducey’s plan. A letter that Arizona Attorney General Mark Brnovich and 20 other state attorneys general sent to Treasury Secretary Janet Yellen regarding the Tax Mandate gives many more examples of proposed tax reforms that were pending before the Act’s passage, which the Tax Mandate now threatens.

Also, the Tax Mandate serves to protect high-tax states from increasing competition from lower-tax states. It’s well known that, for years, taxpayers have been fleeing from poorly managed high-tax states such as California and Illinois to lower-tax states such as Florida and Texas. The pandemic—and vastly increased opportunities for remote work—have accelerated that trend.

So it’s obvious why all of the senators from the high-tax states with the most outmigration voted for the Tax Mandate: to stem their states’ loss of residents and businesses to lower-tax states.

Tax Relief Is COVID Relief

Finally, the Tax Mandate ignores the fact that tax relief is a way that states can provide relief to individuals and businesses that have suffered during the pandemic. Congress knows that’s true: The Act itself provides billions of dollars in federal tax credits.

And it makes sense that, as part of a comprehensive recovery plan, a state would want to use federal funds for COVID relief and also enact tax reforms to encourage business and job growth. Just as a state could supplement federally funded COVID relief with additional state spending on COVID relief—which the Act doesn’t discourage—it could also do so with tax reform.

There’s no good reason why the Act should force states that want to provide extra COVID relief to do so with spending rather than tax cuts. There is only an illegitimate reason: to force states that have managed their finances well to adopt the tax-and-spend policies of states that have managed their finances poorly, which are losing businesses, jobs, and residents to lower-tax states.

That is not only harmful and wrong; it also is directly at odds with our federalist system, which is designed to encourage a diversity of policies and competition among the states.

The Ohio federal court—which has already said that the Tax Mandate is likely unconstitutional—should strike it down. When the Supreme Court has the opportunity, as it almost certainly will, it should do so as well.

You can read more about the state of Ohio’s case—and read the full Goldwater Institute brief—here.

Jacob Huebert is a Senior Attorney at the Goldwater Institute.

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