Ninth Circuit Reverses Federal Win on Challenge to Ban on State Tax Cuts

Good news for taxpayers today from the U.S. Court of Appeals for the Ninth Circuit, which reversed a lower court ruling on the federal government’s controversial attempt to ban state tax cuts.

Background: In 2021, Congress passed the $1.9 trillion American Rescue Plan Act (ARPA), which included $219 billion in extra aid to states. ARPA included a provision banning states from "directly or indirectly" using the money to cut state taxes. The Treasury Department issued regulations explaining that states must submit documentation to the federal government explaining any revenue reductions, and if Treasury determines the explanation to be unsatisfactory, the federal government will take the ARPA money back from the state.

Twenty states sued to have the provision declared unconstitutional for several reasons:

  • The provision is ambiguous ("indirectly" is unlimited in scope and can be applied to almost any state fiscal decision);

  • The provision is coercive as states can't really say no without losing significant amounts of Covid relief funds; and 

  • The provision commandeers state tax policy by effectively directing the state budget process from Washington, a power the federal government does not have directly and violates principles of federalism.

At the trial level, the states have won two-thirds of the cases. The federal government won in 2 cases, where judges found the states lack standing to challenge the provision. All cases are being appealed to the 5th, 6th, 8th, 9th, and 11th Circuits respectively.

(NTUF's Taxpayer Defense Center has filed briefs in every case at every level, arguing the provision is unconstitutional especially due to its use of the word "indirectly." Our background paper from March 2022, with links to all the briefs, is here.)

Today, the Ninth Circuit decision came down in Arizona's challenge. Arizona had lost at the trial level, where the judge ruled that the state lacked standing to challenge the provision. It was one of the two wins the federal government had in ARPA cases. Now the federal government has received a favorable decision in just one case, also on grounds of standing.

The three-judge panel (Judge Gould, a Clinton appointee, and Judges Bennett and Nelson, Trump appointees) concluded that Arizona has standing due both to (1) a sufficiently credible threat of enforcement against it following Arizona's $1.9 billion tax cut and (2) the harm to Arizona’s sovereignty from an allegedly unconstitutional funding offer made to them. The panel rejected a theory of standing based on regulatory burdens of compliance, because the compliance scheme was not established when the complaint was filed. The panel did not proceed to consider the underlying merits, leaving that for the district court. One judge, Judge Nelson, concurred with the majority opinion, disagreeing that the threat of enforcement conferred standing because Arizona did not allege it was engaging in proscribed conduct. The case is State of Arizona v. Yellen, 9th Cir. No. 21-16227.

So what does this mean? It's good news for taxpayers. This is the first appellate decision in the six ARPA cases. It is notable that this Ninth Circuit panel of Clinton and Trump appointees unanimously concluded that Arizona has standing. This is correct: in all the cases involving challenges to the constitutionality of federal conditions on funds to the states, everyone always agreed that states had standing to challenge.

The ARPA provision's ban on what states "indirectly" do with federal funds is a massive expansion of federal power while also managing to be utterly ambiguous. We are pleased to see that the trend of cases is that courts are agreeing with that, and ruling against the federal government.