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Treasury Explains What State Tax Cuts are OK Under ARPA Provision

The U.S. Treasury Department yesterday provided 151 pages of guidance on how states can use federal funds from the American Rescue Plan Act (ARPA), including what kind of tax cuts violate that law’s restriction on using funds to “directly or indirectly offset a reduction in the net tax revenue.” NTUF had previously engaged the Treasury Department to highlight potential issues with ARPA’s state tax budget provisions, and we’ve highlighted where the Treasury Department has addressed our concerns - and where they fall short - below.

The guidance is not so much “the good, the bad, and the ugly” and more “the good, the bad, and the unclear”:

The good:

  • The process will rely on submissions and calculations from state authorities rather than some new Treasury-run certification system. First, each state identifies changes in law, regulation, or interpretation that would result in a reduction in net tax revenue. If the revenue is less than 2019 revenue adjusted for inflation, then calculate any permissible offsets (tax increases, spending cuts except for cuts to areas supported by ARPA funds) to calculate amounts subject to recoupment. Treasury will give notice of recoupment, and a state can request reconsideration by providing an explanation of why the amounts should not be subject to recoupment. Treasury will respond within 60 days with its own explanation.

  • Changes that conform to federal law are excluded. NTUF had included this in our letter to Treasury.

  • Amounts up to a de minimis threshold (1% of baseline tax revenue) are disregarded.

  • Restoring the Unemployment Insurance trust fund to the balance held on January 27, 2020 is a permitted use of ARPA funds. This is an important item because it will prevent otherwise automatic tax increases for employers. NTUF had also asked for this in our request to Treasury.

  • Tax changes scheduled to take place in the future and passed into law  prior to March 2021 are excluded, including implementation or automatic triggers that take effect after March 2021. Likewise, this was included in NTUF’s letter to Treasury.

The bad:

  • The baseline is state fiscal year ending 2019, as adjusted upward for inflation. 2019 was a flush year for state budgets and using it as the baseline means an artificially high level from which tax cuts are calculated. Treasury does indicate that intergovernmental transfers, ARPA funds, and utility revenue are excluded but those will not nudge 2019 numbers much. This may become less of an issue in future years as revenues rise above the 2019-plus-growth level.

  • The guidance is silent on permitting state tax cuts that further APRA objectives but are not strictly conforming changes, such as cutting business taxes for retailers or paying out checks to essential workers. Presumably these are permitted if directly spent but not if done via tax cuts.

The unclear:

  • "Refunds and correcting transactions" are excluded. While refunds are clear enough, less clear is what would happen if a court invalidates a state tax. Is that a "tax cut" or a "refund or correcting transaction"?

  • The recoupment mechanism does allow for states to dispute a Treasury determination but there's no way for a state to get advance OK for a tax cut it wants to do. Treasury’s mechanism is backward-looking, after the close of the fiscal year. On the other hand, because it is backward-looking, if state revenue grows enough to outstrip the tax cut then no recoupment occurs. (The guidance gives the example of a state that cuts taxes by $1 billion, makes no other changes, and sees organic revenue growth of $500 million. The state would have to repay $500 million. So while states are barred from using dynamic scoring in projections, the growth still counts if it occurs.)

  • While guidance focuses on total spending, the mechanism looks at each identified change in law or regulations to determine the revenue loss associated with them. If the trees added up don’t equal the forest, the guidance gives no direction on what happens. Presumably, since the state essentially bears the burden of "proving" that its tax cut is permitted, recoupment would be the default result.

Generally, the state-led process and de minimis thresholds indicate that the Treasury Department doesn't want this provision used for random fishing expeditions. However, the guidance doesn't counter the main constitutional argument in the six currently pending lawsuits: that this provision effectively subordinates state tax policy to what the federal government considers permissible. Those six lawsuits (Ohio, Missouri, Arizona, West Virginia, Kentucky, and Texas) are likely to continue moving forward.