Pandemic relief bill shouldn’t hinder states on tax relief

Written by Derek Monson

March 25, 2021

One controversial measure from the $1.9 trillion American Rescue Plan Act (recently passed by Congress and signed by President Biden) is the bill’s attempt to use the $350 billion for state and local governments to restrict tax relief policy reforms by state governments. The federal attempt to influence state tax policy is so contentious that more than 20 state attorneys general (including Utah’s) threatened to sue the Biden administration over it, and Ohio’s attorney general has already filed a lawsuit – calling the restriction a “gun to the head of states” during a pandemic.

Can the federal government discourage tax relief in this way under the Constitution? Possibly. If it can, should it? No.

The language of the new law says that “a State or territory shall not use the funds provided under this [law] … to either directly or indirectly offset a reduction in the net tax revenue of” the state between 2021 and 2024 through reforms such as lowering tax rates, increasing tax credits, or delaying higher taxes. If a state uses COVID relief funding to offer tax relief, they must pay back the federal government the amount of funding used for tax relief.

This policy creates an incentive for states to avoid offering tax relief so they do not have to pay pandemic relief funds back to the federal government. The Treasury Department clarified that states could still take COVID relief funds and reduce taxes, but they must use state tax funds to do so or risk having to repay COVID relief funds in the amount of tax relief generated. However, there remains significant uncertainty over how Treasury will determine whether a state used COVID relief funds indirectly to reduce net tax revenue, meaning the anti-tax-cut incentive still remains.

There is sufficient evidence to conclude that the federal government can regulate state tax policy to some extent under the U.S. Constitution. Based on Supreme Court rulings and past federal law, legal scholars have concluded that Congress “almost certainly does have the power” to prevent states from taxing certain things (e.g., nonresident retirement income, internet access, etc.).

Does the federal government’s authority to prevent states from taxing certain items imply that they can prevent states from reducing taxes? It is possible, but it remains an unanswered question. The Supreme Court may ultimately decide that constitutional question through the Ohio attorney general’s lawsuit.

It is an entirely separate question as to whether Congress and the president should attempt to restrict tax relief policies from states. In Federalist 45, James Madison wrote:

The powers reserved to the several States will extend to all the objects which, in the ordinary course of affairs, concern the lives, liberties, and properties of the people, and the internal order, improvement, and prosperity of the State. The operations of the federal government will be most extensive and important in times of war and danger; those of the State governments, in times of peace and security.

The framers of the Constitution believed that states would and should control most policy matters impacting citizens’ day-to-day lives the most, such as most taxation. They built in safeguards and checks on state’s policymaking powers, as they built into the Constitution checks and balances against governing power exercised by any branch or level of government. But these checks were not intended to be used as a Constitutional loophole through which a faction in the federal government could impose a particular policy agenda (e.g., opposition to lower government revenue) on the entire nation, as the state tax restriction in the pandemic relief bill attempts to do.

In short, using a pandemic relief bill to influence or manipulate the tax policies of the states is a bad idea because it is not how our system was designed to work. And when you use something in a way that it isn’t designed to work, it often results in the thing not being able to do what it was intended for.

Hopefully, the federal courts recognize these civic impacts of the tax relief restriction policy in the COVID relief bill and overturn it. Washington, D.C., is dysfunctional enough without importing its dysfunction to all of the 50 states.

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