Governor Kim Reynolds signed Iowa on to a lawsuit challenging part of the federal government’s most recent COVID-19 relief package. Thirteen states filed suit in Alabama on March 31, charging that the American Rescue Plan “impermissibly seizes tax authority from the States.” Reynolds announced the lawsuit during a March 31 appearance on WHO Radio’s program hosted by Simon Conway. The Associated Press was first to report the news.
AN “UNTENABLE CHOICE” FOR STATES
On the whole, the American Rescue Plan’s $350 billion in assistance to state, local, and tribal governments comes “with very few strings attached,” Richard C. Auxier pointed out in a commentary for the Tax Policy Center.
Unlike the CARES Act, which originally restricted spending to pandemic-related expenses, states can use ARP dollars to respond to the public health emergency, replace lost tax revenue, offset the pandemic’s negative economic effects, or invest in infrastructure.
But states cannot use ARP money to fund tax cuts or contributions to their public employee pension plans. A state that does risks losing every federal dollar spent in violation of the rule.
The relevant language is in section 9901 of the bill. The states suing the federal government assert that what they call a Federal Tax Mandate “sets up an untenable choice” for states: “either relinquish control over a core function of their inherent sovereign powers, or else, in the midst of a deadly and destructive pandemic, forfeit massive and much-needed aid […].”
The complaint details possible impacts on all the plaintiff states, noting tax cuts Iowa enacted in 2018, which “are contingent on satisfaction of certain triggers based on the level and growth of net general fund revenues.”
If those triggers are satisfied, the State of Iowa would be required to adopt changes to tax regulations that could take effect during the period covered by ARPA. The Iowa General Assembly is also considering a number of other bills that could reduce tax revenue. For example, the Iowa Senate unanimously passed a bill eliminating the state inheritance tax and removing the triggers for further tax cuts so that the reduction would go into effect automatically in 2023. And the Iowa House of Representatives nearly unanimously passed a bill establishing child care tax credits. Given the ambiguous and broad nature of the Federal Tax Mandate, it is unclear whether any of these bills or previous enactments would subject Iowa to penalty under that statute.
“REASONABLE FUNDING CONDITIONS” NOT UNUSUAL
Reynolds told Conway that states had reached out to Treasury Secretary Janet Yellen for clarification on whether the legislation stripped states of their taxing authority and “received a very vague response.” I’ve enclosed below a letter Yellen sent to state attorneys general on March 23. She noted that Congress “routinely” puts “reasonable” conditions on how states may use federal funding for roads, education, or Medicaid, and that earlier COVID-19 relief packages also “barred States from spending those funds on certain ineligible expenditures.” The Treasury secretary added,
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.
The Associated Press noted that Attorney General Tom Miller’s name did not appear on the lawsuit, and his office did not announce the suit, as has been typical when Iowa participated in multi-state suits. Iowa is the only plaintiff state in this case that has a Democratic attorney general.
Iowa law has long allowed the governor to sign on to multi-state lawsuits, whether or not the attorney general agrees with the legal rationale. For example, Governor Terry Branstad joined one of the challenges to the Affordable Care Act in 2011.
Traditionally, Iowa’s attorney general has also been able to exercise independent judgment on lawsuits against the federal government. However, Miller relinquished that authority under an informal agreement with Reynolds in 2019. Now the Attorney General’s office does not join such lawsuits without the governor’s permission.
LARGER LEGAL ISSUES AT PLAY
Prospects for the new lawsuit’s success may depend on Treasury’s more detailed guidance to come. As Auxier pointed out, some states are considering tax cuts that align with the goals of the COVID-19 relief package, such as increasing the earned income tax credit, or exempting the first $10,200 in unemployment benefits from taxation. So Treasury may not issue a “blanket restriction” on all tax cuts during the covered period.
In charging that the American Rescue Plan violates the Tenth Amendment to the U.S. Constitution, the lawsuit cites a 2012 U.S. Supreme Court ruling. In that case, seven justices struck down the Affordable Care Act’s requirement that states expand Medicaid or lose all federal Medicaid funding. The majority opinion by Chief Justice John Roberts found that provision coercive: “[t]he threatened loss of over 10 percent of a State’s overall budget . . . is economic dragooning that leaves the States with no real option but to acquiesce.”
Writing in The New Republic on March 29, Simon Lazarus and Robert Litan warned that “Sloppy language” on tax cut restrictions could jeopardize the whole American Rescue Plan. The COVID-19 relief package could provide close to 10 percent of some state budgets for the coming fiscal year.
There is a short and easy answer to the [Ohio] attorneys general’s beef, precisely the explanation [Senator Joe] Manchin provided in introducing his amendment: If a state “offsets” the relief funds with a tax cut, then it did not need the funds in the first place and thus could not have been “coerced” into accepting them. But that response does not answer the Republicans’ additional complaint that, because dollars are fungible, the word “indirectly” could, if literally interpreted, bar any reduction in tax revenues, no matter how trivial and no matter how clearly unrelated to receipt of the relief funds. […]
More concerning, a legal battle over the amendment could trigger a radically far-reaching judicial rebuff. The amendment grants broad authority to the Treasury to interpret statutory language, providing the Court’s right-wing justices a tempting opportunity to deliver on a threat to kneecap the so-called administrative state.
Along those lines, Ian Millhiser recently reviewed how the Supreme Court “is poised to give itself a veto power over much of the Biden administration’s authority.”
Appendix: Excerpts from Treasury Secretary Janet Yellen’s March 23 response to state attorneys general
I write in reply to your March 16, 2021 letter regarding Treasury’s implementation of section 9901 of the American Rescue Plan Act (the “Act”), which provides funds to States, territories, Tribal governments, and localities to help them manage the economic consequences of COVID-19.
In the Act, Congress has provided funding to help States manage the public health and economic consequences of COVID-19 and it has given States considerable flexibility to use that money to address the diverse needs of their communities. At the same time, Congress placed limitations to ensure that the money is used to achieve those purposes – including provisions stating that this funding may not be used to offset a reduction in net tax revenue resulting from certain changes in state law.
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.
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.
It is also important to note that States choosing to use the federal funds to offset a reduction in net tax revenue do not thereby forfeit their entire allocation of funds appropriated under this statute. The limitation affects States’ ability to retain only those federal funds used to offset a reduction in net tax revenue resulting from certain changes in state law.
Treasury is crafting further guidance-including guidance to address more specifically the issues raised by your letter and the procedures Treasury will use for any future recoupment-that will provide additional information about how this provision will be administered. […]