Treasury Adopts Final Rule Explaining What State Tax Cuts Are OK Under ARPA Provision

The U.S. Treasury Department’s final rule on permitted uses of federal American Rescue Plan Act (ARPA) funds came out today. It’s 437 pages and you can read it all here, but key things that jumped out to me as I read it, compared to the 151-page interim rule (on which we had written requesting clarification):

  • Treasury rejected efforts to allow funds to be used for general infrastructure projects. Only projects for broadband, water and sewer, and something related to and proportional to pandemic public health qualify. (p. 214-219)
     
  • Use of funds to cover government revenue losses: States can use the formula first laid out in the interim rule (which instructs them to compare actual revenue to “counterfactual revenue” calculated by extrapolating average revenue growth over a three year period, or by using the nationwide average of 5.2 percent over that period), or alternatively, a fixed $10 million standard allowance. (p. 233-243). States can also choose to exclude government-operated utility and liquor store revenue. (p. 243-247)
     
  • Defining “due to”: The statute says the federal aid can cover state or local revenue losses “due to” the pandemic, and the interim rule simply presumed that any revenue losses were due to the pandemic. The final rule maintains this but adds that any tax cuts made after the adoption of the final rule (January 6, 2022) are not revenue losses “due to” the pandemic. Therefore, recipients must “determine the amount of revenue that would have been collected in the absence of the tax cut…[without using] macroeconomic growth…in determining their actual revenue totals.” States that increase taxes after January 6, 2022 can also subtract those in the calculation, meaning that a state can raise taxes without it “counting against” the federal aid they get to address a budget shortfall! (p. 247-255)
     
  • Ban on state tax cuts: The statute prohibits using funds “to either directly or indirectly offset a reduction in…net tax revenue…or delays the imposition of any tax or tax increase.” I’ve written extensively on the utter ambiguity of that phrase, particularly by the inclusion of “indirectly” which if literally understood would encompass everything. 20 states are suing in six different lawsuits challenging the provision’s constitutionality (NTUF has filed briefs in all the cases to date). The interim rule essentially pretended “indirectly” was not in the statute and laid out a formula for comparing tax revenue before the pandemic (plus a growth factor) with current revenue, and requiring states to justify any reductions as being “paid for” by something other than federal aid. In its own words, Treasury “is finalizing its implementation of the offset provision largely without change.” (p. 322)

The interim rule’s carveouts therefore remain: tax cuts enacted prior to the pandemic even if they took effect during it; changes that conform with federal tax law; use of FY 2019 as the baseline year; a de minimis exclusion of 1 percent; and a process where states can request reconsideration if found to be in violation. Treasury’s narrative frequently references “[s]everal commenters” who wanted the interpretation to be more restrictive on preventing tax cuts (such as by using FY 2020 as the baseline, eliminating the de minimis, excluding state cash on hand prior to the pandemic, etc.), and while Treasury did reject those suggestions, that they were even submitted is alarming.

The final rule adds the following: states only have to justify reductions if they are in excess of the 1 percent de minimis; and, ominously that “Treasury may address potential violations of this final rule based on both information submitted from recipients…and from other sources of information (e.g., information submitted from the public).” (p. 339.) People who don’t like tax cuts will therefore be able to tattle on their state to the feds!

The final rule, like the interim rule, arbitrarily penalizes states for doing policy via tax cuts rather than direct spending. Suspending business taxes on restaurants or cutting income taxes for struggling taxpayers would trigger Treasury’s ire, but sending out checks would not. The new provision that still requires states to submit explanations on their fiscal policy to the federal government but now allows Treasury to identify “potential violations” from “other sources of information” just invites fishing expeditions on an already constitutionally dubious provision. The state already has to “prove” that they didn’t “indirectly” use federal funds for any tax cut, and now they’ll have to defend against arguments unknown.

The final rule doesn’t address, and in fact reinforces, the argument that the “offset provision” is unconstitutional. Yes, the feds can place conditions to some degree on direct uses of federal aid. But conditions that amount to federal supervision of state tax policy – guilty until you prove yourself innocent, on even indirect uses of federal aid – go too far. Two federal judges have already so ruled, and the Ninth Circuit will consider the issue on January 13 and the Sixth Circuit on January 26. Stay tuned.