Thirteen more states are suing the Department of Treasury to block a provision in the federal COVID-19 relief law that restricts federal aid from being used to offset reductions in tax revenue.
The suit, filed March 31 in the U.S. District Court for the Northern District of Alabama, charges that a provision of the $1.9 trillion American Rescue Plan Act of 2021 (P.L. 117-2) “sets up an untenable choice for the plaintiff states” because “they must 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 that represents approximately 25 percent” of their respective annual budgets.
While states will be able to use the aid to cover budget deficits, the act contains a provision that restricts it 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.”
Attorneys general in Arizona, Missouri, and Ohio have also filed suit over the provision.
The latest lawsuit was filed by bipartisan attorneys general in West Virginia, Alabama, Arkansas, Alaska, Florida, Iowa, Kansas, Montana, New Hampshire, Oklahoma, South Carolina, South Dakota, and Utah.
The states argue that the provision is an unconstitutional exercise of federal power that violates the 10th Amendment of the U.S. Constitution and the anti-commandeering doctrine. The plaintiffs are seeking to prevent the department and other agencies or employees from enforcing the provision.
“Earlier this month, Congress passed and President Joe Biden signed into law the American Rescue Plan Act, which contains a provision that effectively bans states from cutting taxes for several years,” Alabama Attorney General Steve Marshall (R) said in a release.
“This federal tax mandate is an unprecedented and unconstitutional assault on state sovereignty by the federal government, which would commandeer the State of Alabama’s sovereign power to tax and spend and determine her own fiscal policies,” Marshall continued. “Today, I and 12 other state attorneys general filed suit against the Biden administration to block the enforcement of this grievous federal encroachment on states’ rights.”
Most of the 13 attorneys general are among 21 Republican attorneys general who sent a letter to Treasury Secretary Janet Yellen March 16, requesting prompt clarification from Treasury that the law doesn’t prohibit states from using the aid to generally provide tax relief.
In the letter, the attorneys general said that if guidance wasn’t issued by March 23, “we will take appropriate additional action to ensure that our States have the clarity and assurance necessary to provide for our citizens’ welfare through enacting and implementing sensible tax policies, including tax relief.”
Yellen responded to the concerns in a March 23 letter saying, “Nothing in the act prevents states from enacting a broad variety of tax cuts,” but rather 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 Treasury secretary said.
Yellen also responded to concerns that the provision could be unconstitutional, noting that 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.
Treasury did not respond to a request for comment on the lawsuit by press time.
Ruth Mason, professor of law and taxation at the University of Virginia, told Tax Notes in an email that generally, it is hard for states to win conditional spending cases because the state can always turn down the federal money.
“But [the National Federation of Independent Business] reinvigorated the test the Supreme Court set out for conditional grants in South Dakota v. Dole. Congress does not have the power under the Constitution to forbid states from cutting taxes,” Mason said.
Under the spending doctrine, Congress can essentially bribe the states to do what it wants, but there are limits to Congress’s ability to bribe, under Dole and subsequent cases, Mason explained.
“More broadly, allowing the federal government to co-opt state taxes in this way would set a dangerous precedent. Federal control over state taxes represents a threat to our federal system, at least if we accept that the tax power is the wellspring of state autonomy,” Mason said.