Status of challenges to the ARPA state tax mandate

ARPA State Tax Mandate

 

The American Rescue Plan Act (ARPA) is an economic stimulus bill passed by Congress and signed into law by President Joe Biden on March 11, 2021. As part of the bill, ARPA established a Coronavirus State Fiscal Recovery Fund in which Congress appropriated $220 billion for states, U.S. territories and tribal governments to mitigate the fiscal effects of the COVID-19 pandemic. 

 

Funds may be used for a broad range of state and local governmental costs and aid, assisting households, small businesses and not-for-profit organizations; grants and premium pay for essential workers; infrastructure investments; and aid to pandemic-affected industries such as tourism, travel and hospitality.

 

To ensure that the money is used to help states fund public programs as intended and not to make up a resulting revenue shortfall, Congress requires that the funds not “directly or indirectly offset a reduction in the net tax revenue”1 of a recipient state by a “change in law, regulation, or administrative interpretation.”[SM1] [WM2] 1 This restriction is known as the State Tax Mandate.

 

As of October 2021, at least 17 states were considering state tax cuts. Currently, 21 states are involved in one of six lawsuits challenging the State Tax Mandate:

1. Ohio: Ohio v. Yellen2  
2. Alabama, Alaska, Arkansas, Florida, Iowa, Kansas, Montana, New Hampshire, Oklahoma, South Carolina, South Dakota, Utah and West Virginia: West Virginia et. al. v. U.S. Dept. of the Treasury et. al.3
3. Missouri: Missouri v. Yellen4
4. Arizona: Arizona v. Yellen5
5. Kentucky and Tennessee: Commonwealth of Kentucky et al. v. Yellen6
6. Texas, Mississippi and Louisiana: Texas et al. v. Janet Yellen et al., Case 2:21-cv-00079-Z (USDC: N.D. TX Amarillo Division 2022)7

 

Background

 

Congress’ power to provide conditional grants to states is broad but not unlimited. According to the U.S. Constitution’s Spending Clause (Article I, Section 8, Clause 1), Congress can levy taxes and spend money, “to provide for the common defense and general welfare of the United States.”[SM3] [WM4] 8 Spending may include offering grants to state governments provided that the recipients agree to conditions to obtain funds.

 

When states challenge Congress’ exercise of spending powers, what is generally at issue is whether conditions placed on receipt of funds violate states’ [SM5] [WM6] rights. That is, the federal government has only those powers delegated to it by the Constitution, and all other state powers not forbidden by the Constitution are reserved to each state.

 

In South Dakota v. Dole,9 the Supreme Court decided a case involving withholding federal highway funds from states that did not maintain a legal drinking age of 21. In deciding that the restriction did not infringe on states’ rights, the Court established a five-part test to determine whether a condition imposed by Congress was proper. Relevant to the State Tax Mandate, to be proper, a condition must 1) be unambiguous, and 2) not be coercive.

 

Ohio v. Yellen – States’ Rights Arguments

 

Ohio v. Yellen (March 2021) was the first of the lawsuits filed. Ohio sought to enjoin 0the U.S. from enforcing the State Tax Mandate. Ohio’s main arguments were that Congress exceeded its constitutional limits as follows (using the relevant S.D. v. Dole criteria):

 

• Ambiguous: Because money cannot be specifically tracked, any money received will, at least indirectly, offset a reduction in the net tax revenue of a state that reduces the tax burden of its citizens. Essentially, every change in tax policy that leads to a decrease in tax revenue would violate the State Tax Mandate.

 

• Coercive: Essentially, because the states are being offered so much money after the pandemic decimated budgets, states don’t really have the option to turn down the ARPA funding.
  • Standard used: National Federation of Independent Business (NFIB) v. Sebelius10 in which the Supreme Court struck down a provision of the Affordable Care Act requiring states to extend Medicaid or lose all existing Medicaid funding. Justice Roberts likened this conditional grant to a “gun to the head” because, due to how federal funding of Medicaid worked, if a state declined, it could lose at least 10% of their entire existing operating budget.
  • Ohio’s argument: The coercion arises because the ARPA is generous. That is, the ARPA would provide Ohio with $5.5 billion in federal funds, and in the current economic situation, no state can turn down this financial inducement. So, there is no real option but to take the funds.

 

While Ohio’s suit for injunction was pending, the IRS issued guidance regarding the State Tax Mandate.[SM7] [WM8] 

 

Part 2 of this article will continue this analysis of the status of ARPA’s State Tax Mandate.  The IRS’s guidance and its impact on the Ohio case, and the status of all of the state tax mandate litigation will be covered.  Stay tuned.

 

Reference

1. P.L. 117-2: American Rescue Plan Act of 2021, Title IX, Subtitle M - Coronavirus State and Local Fiscal Recovery Funds, Sec. 602(c). https://www.congress.gov/117/bills/hr1319/BILLS-117hr1319enr.pdf
2. Ohio v. Yellen, 547 F.Supp. 3d 713 (USDC: S.D. Ohio Western Division 2021)[SM9] [WM10] .  https://www.ohioattorneygeneral.gov/Files/Briefing-Room/News-Releases/Tax-Mandate.aspx
3. West Virginia et. al. v. U.S. Dept. of the Treasury et. al., Case No. 7:21-cv-00465 (USDC: E.D. KY Central Division 2021). https://casetext.com/case/west-virginia-v-united-states-dept-of-treasury
4. Missouri v. Yellen, 538 F.Supp.3d 906 (USDC: E.D. MO 2021). https://casetext.com/case/missouri-v-yellen
5. Arizona v. Yellen, 550 F.Supp. 3d 791 (USDC: AZ 2021).  https://casetext.com/case/state-v-yellen-7
6. Commonwealth of Kentucky et al. v. Yellen, Case No. 3:21-cv-00017-GFVT-EBA (USDC: KY Central 2021).  https://casetext.com/case/commonwealth-v-yellen
7. Texas et al. v. Janet Yellen et al., Case 2:21-cv-00079-Z (USDC: N.D. TX Amarillo Division 2022). https://casetext.com/case/state-v-yellen-8?q=Case%202:21-cv-00079-Z%20&sort=relevance&p=1&type=case
8. “Article I Section 8, Constitution Annotated.” Library of Congress, n.d. https://constitution.congress.gov/browse/article-1/section-8/.
9. South Dakota v. Dole, 483 U.S. 203 (1987[WM11] ). https://supreme.justia.com/cases/federal/us/483/203/
10. National Federation of Independent Business (NFIB) et al. v. Sebelius, Secretary of Health and Human Services, et al. NFIB v. Sebelius, 567 U.S. 519 (2012). https://www.supremecourt.gov/opinions/11pdf/11-393c3a2.pdf

 

IRS Guidance

 

In May 2021, the IRS issued an Interim Final Rule regarding the State Tax Mandate. The Interim Final Rule first discussed the purpose of the Funds as follows:

 

• Support public health expenditures, by funding COVID-19 mitigation efforts, medical expenses, behavioral healthcare, and certain public health and safety staff;
• Address negative economic impacts caused by the public health emergency, including economic harms to workers, households, small businesses, impacted industries, and the public sector;
• Replace lost public sector revenue, using this funding to provide government services to the extent of the reduction in revenue experienced due to the pandemic;
• Provide premium pay for essential workers, offering additional support to those who have borne and will bear the greatest health risks because of their service in critical infrastructure sectors; and,
• Invest in water, sewer, and broadband infrastructure, making necessary investments to improve access to clean drinking water, support vital wastewater and stormwater infrastructure, and to expand access to broadband internet.

 

Specific to the mandate, the Interim Final Rule requires that any state or territory that cuts taxes must demonstrate how it paid for the tax cuts from sources other than Coronavirus State Fiscal Recovery Funds — by enacting policies to raise other sources of revenue, by cutting spending or through higher revenue due to economic growth. States that used funds to offset tax cuts must pay that amount back to the Treasury.

 

The framework for determining whether a state used the funds to offset net tax revenues is done through information reported annually by a recipient state:

 

1. The state will identify and value the changes in law, etc., that would result in a reduction of net revenue as it would in the ordinary course of its budgeting process. This reduction must be paid for by sources other than American Rescue Plan Act (ARPA) funds.
2. If the total value of the changes in the year for which the state is reporting is below a de minimis level, the state need not identify any sources of funding to pay for revenue-reducing changes and will not be subject to recoupment. The de minimis level is 1% of the state’s 2019 tax revenue adjusted for inflation (the baseline).
3. The recipient government will consider the amount of actual tax revenue recorded in the year for which they are reporting. If the recipient government’s actual tax revenue is greater than the amount of tax revenue received by the recipient for the fiscal year ending 2019, adjusted annually for inflation, the recipient government will not be considered to have violated the offset provision because there will not have been a reduction in net tax revenue.
4. If there is a reduction in net tax revenue (over the de minimis), the state will identify the sources used to permissibly offset the changes such as increases in general fund revenues and spending cuts in areas not being replaced by ARPA funds.

 

A state will not be required to repay to more than the difference between the actual revenue shortfall and the 2019 baseline (adjusted for inflation).

 

Ohio v. Yellen – Permanent Injunction Granted

 

After hearing arguments and considering the IRS Interim Final Rule, the District Court granted Ohio’s request for a permanent injunction based solely on the ambiguity argument. The following is a synopsis of the District Court’s rationale:

 

• Ambiguity: Statute found to be ambiguous.

• Quoting from the NFIB case, “[i]n our federal system, the National Government possesses only limited powers; the States and the people retain the remainder.”1
• States have the power to govern (“police power”) with limited right of the federal government to supersede which “if not checked in any way, would present a grave threat to the system of federalism created by our Constitution.”1
• “Viewing the Spending Clause relationship between a State and the federal government as a contract, the Supreme Court has stated that the legitimacy of Congress’ power to legislate under the spending power thus rests on whether the State voluntarily and knowingly accepts the terms of [at] contract.”2[SM12] [WM13] 
• “It is not sufficient that the state receives funds merely knowing that some kind of strings are attached. Rather, the question is ‘whether such a state official would clearly understand the obligations’2 attendant in accepting the grant.”2
• States cannot knowingly accept conditions of which they are unaware or that they cannot establish.
• Congress must speak in a clear voice.
•  “Even though divining the exact standard for unconstitutional ambiguity under the Spending Clause may be difficult, that matters little here. That is because the
• Tax Mandate, even when read in context, fails to put the State on ‘clear notice’ of its obligations.”2
  • Change in law — clear
  • Reducing any tax — clear
  • Unclear — What does indirectly offsetting a reduction in net tax revenue mean? It assumes a baseline, which the Interim Final Rule provided but the statute did not.
• Sweeping language: Based on the tax mandate’s language, essentially any reduction in the rate of any one or more state taxes — even if other tax rates were increased — could be a “change in [tax] laws”2 that results in an “indirect offset [of] a reduction in [Ohio’s] net tax revenues.”2
• The Interim Final Rules do not cure statutory ambiguity, and Congress did not grant Treasury the authority to cure.

• Coercion was not addressed.

 

The District Court found that the Tax Mandate’s language falls short of the clarity required to sustain a spending condition.

 

Treasury appealed Ohio v. Yellen to the 6th Circuit in September 2021. The 6th Circuit heard arguments on January 26, 2022.  As of April 11, 2022, no decision has been published.

 

Other Cases

 

West Virginia et. al. v. U.S. Dept. of the Treasury, et. al:3

• On Nov. 15, 2021, the District Court held in favor of West Virginia and a dozen other states, permanently preventing the U.S. Treasury from clawing back ARPA funds that states may use directly or indirectly to offset revenue losses from a tax cut. Accordingly, the District Court stated that the IRS Interim Final Rule cannot change the restriction from being a federal overreach.
• Although based in the ambiguity argument, the District Court echoed coercion concerns when it stated that, “[t]he Tax Mandate’s restriction on direct or indirect state tax cuts pressures States into adopting a particular—and federally preferred—tax policy.”3
• As of April 11, 2022, Treasury has filed an appeal of the District Court decision with the 11th Circuit (USCA11 Case: 22-10168).   

 

Missouri v. Yellen4 and Arizona v. Yellen5:

• District Court judges in Missouri and Arizona have dismissed these challenges, holding that states do not have standing to sue because they cannot prove harm since Treasury has yet to recoup any funds.
• As of April 11, 2022, both of these cases are on appeal with their respective appeals courts (8th and 9th Circuits), but no decisions have been published.

 

Commonwealth of Kentucky, et al. v. Yellen6:

• A permanent injunction was granted (similar to Ohio and West Virginia cases).
• As of April 11, 2022, Treasury has not filed an appeal of this decision.

 

Texas et al. v. Janet Yellen et al.7:

• The District Court decision in this case was published on April 8, 2022, in favor of the states. A permanent injunction was granted. 

Treasury has not yet filed an appeal of this decision.

 

Wrap-up

 

As of April 11, 2022, states are 4-2 when challenging the State Tax Mandate at the trial level, and four cases are under appeal. Because of the inconsistency in decisions and Treasury’s willingness to appeal, it is likely that the State Tax Mandate will make its way to the Supreme Court. Stay tuned.

 

Reference

 

1.  National Federation of Independent Business (NFIB) et al. v. Sebelius, 567 U.S. 519 (2012). https://www.supremecourt.gov/opinions/11pdf/11-393c3a2.pdf

2.  Ohio v. Yellen, 547 F.Supp. 3d 713 (USDC: S.D. Ohio Western Division 2021). https://www.anylaw.com/case/state-of-ohio-v-secretary-department-of-treasury-et-al/s-d-ohio/07-01-2021/cE0Rb34B-wqeFATahCeD.

3.  West Virginia et. al. v. U.S. Dept. of the Treasury et. al., Case No. 7:21-cv-00465 (USDC: E.D. KY Central Division 2021). https://casetext.com/case/west-virginia-v-united-states-dept-of-treasury

4. Missouri v. Yellen, 538 F.Supp.3d 906 (USDC: E.D. MO 2021). https://casetext.com/case/missouri-v-yellen
5.  Arizona v. Yellen, 550 F.Supp. 3d 791 (USDC: AZ 2021).  https://casetext.com/case/state-v-yellen-7
6. Commonwealth of Kentucky et al. v. Yellen, Case No. 3:21-cv-00017-GFVT-EBA (USDC: KY Central 2021). https://casetext.com/case/commonwealth-v-yellen
7. Texas et al. v. Janet Yellen et al., Case 2:21-cv-00079-Z (USDC: N.D. TX Amarillo Division 2022). https://casetext.com/case/state-v-yellen-8?q=Case%202:21-cv-00079-Z%20&sort=relevance&p=1&type=case