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States Appear Undeterred in Suing on Relief Spending Limits (1)

May 11, 2021, 7:27 PM; Updated: May 12, 2021, 12:02 AM

States eager to use federal coronavirus relief money won some leeway from the Treasury Department in how they may deploy it without violating a prohibition on cutting taxes with it. But the guidance isn’t enough to end Republican state lawsuits against the ban.

Interim final rules released by the Treasury Department on Monday permit states to issue tax relief under their own tax authorities as long as the relief amounts to no more than 1% of a state’s 2019 reporting year’s total revenue. It also allows them to adjust for inflation. But for larger tax changes states must show how they plan to offset any potential net revenue changes without using the $350 billion sent to them in the latest relief law.

States have argued the limitation is an attack on their sovereign powers. In its proposal, Treasury acknowledged that states need some fiscal space in the event that budgetary changes alter tax revenues. They also considered that states may see minor revenue adjustments different than initial projections that wouldn’t necessarily be tied to tax law changes.

“It is giving states room to maneuver, and it’s really giving them room to pass tax cuts,” though they may not end lawsuits, said Richard Auxier, a senior policy associate in the Urban-Brookings Tax Policy Center.

The Biden administration’s initial bid at addressing states’ concerns did little to assuage Republican attorneys general from Ohio and Arizona in their lawsuits, arguing Treasury’s lawyers “can’t fix an unconstitutional law.”

“These meaningless directives on enforcing this tax mandate ought to be treated with the same seriousness as other pieces of fantasy fiction,” Ohio Attorney General Dave Yost said. Arizona Attorney General Mark Brnovich said Treasury had yet to provide clear guidelines. “Arizona should not be in a position of losing billions of dollars because the federal government wants to commandeer states’ tax policies,” he said.

Chris Nuelle, a spokesman for Missouri Attorney General Eric Schmitt, said the agency is reviewing the rule, but declined to comment further on the matter. A representative for Alaska Attorney General Treg Taylor declined to comment.

Laurence Tribe, a professor of constitutional law at Harvard University, expressed skepticism about states’ ability to win their challenges following Treasury’s latest rules. “This interim guidance seems to me sufficient to overcome any legitimate red state constitutional objections,” he said.

Missouri lacked standing to bring its challenge to the spending restriction, a judge said, dismissing it Tuesday in the U.S. District Court for the Eastern District of Missouri.

Safe Harbors

The guidance offers a few safe harbors. States with depleted unemployment trust funds will be able to backfill their reserves to pre-pandemic levels, allowing some to stave off automatic tax hikes on employers. It also allows for legislation in states like California and Maryland that conforms state law to new credits and deductions created by a previous federal relief law.

“The states that did not want to file lawsuits will be happy to have safe harbors that should help with minor cuts,” said Chris Moran, a tax lawyer at Venable LLP in Baltimore. But he said “this should not change things for the states that put the time in to sue or complain about the law.”

The interim final rules require states that make larger tax cuts after March 3, 2020, to identify funds from other sources that would offset any reduction—tapping into organic economic growth that increases collections, for example, or increasing tax rates or cutting program spending. West Virginia, one of the states suing, pursued its largest cut in history in a recent legislative session.

There is room for states to misinterpret the guidance or miscalculate a tax change, said Jeff Friedman, a partner at Eversheds Sutherland’s Washington office.

“The 150 pages that they have to use is very complicated, and the consequences of being wrong are pretty significant,” Friedman said. “The complication will feed into the states’ narrative that the federal government is being intrusive, as it forces debate not only on isolated tax provisions, but states will also will have to consider all their tax revenues every time they consider a tax reduction.”

Republican lawmakers and attorneys general argue Congress’ tax cut prohibition is an unconstitutional overreach into state governance and illegal in its ambiguity. Treasury’s rules acknowledge that states may need more clarity on specific changes, and promise further guidance on how the department will work with them to bless specific proposals.

That could actually help the states’ case, according to Bruce Ely, a state and local tax partner with Bradley, Arant, Boult, Cummings LLP in Alabama.

“You run this sort of gauntlet every time you want to deliver relief to a targeted group such as small businesses,” Ely said. “It illustrates the bad tax policy behind this provision, that states are going to have to ask ‘Mother, may I?’ before they do anything.”

Michael Leachman, vice president for state fiscal policy at the Center on Budget and Policy Priorities, disagreed. He said allowing changes under 1% and adjustments for inflation should let states make most decisions with confidence, as state budgets tend to outpace inflation.

“The safe harbors were pretty generous,” he said. “It’s all pretty clear that you don’t have to run every little idea past Treasury.”

‘No Choice’

The added flexibility, however, may do little to deter lawsuits, because of politics. “If you’re in the attorney general’s office and you’re led by a Republican, you probably didn’t read one word of this, and said, ‘I’m still going to sue them,’ because I want to sue the Biden administration because I get to sue in the just cause of tax cuts,” Auxier said.

Ohio, in its March 17 complaint, argued that Congress coerced the state into accepting the limitation, given that the state had “no real choice” but to accept an estimated $5.5 billion under the pandemic relief law.

“Congress violates its Spending Clause power when it coerces States into agreeing to limit their sovereign authority of offering financial inducements that States cannot practically refuse,” the state’s attorneys wrote.

Ohio’s lawsuit against Treasury has drawn the support of 74 Republican lawmakers, including Rep. Kevin Brady (R-Texas), who also introduced legislation (H.R. 2189) in late March to rescind the provision.

“There’s wide consensus that this is an overreach,” Brady said. “States have the authority on tax policy.”

Arizona argues similarly in its suit, claiming the relief bill presents States with effective offers they can’t refuse with ravaged budgets due to a once-in-a-century pandemic. Separately, in a joint complaint led by the state of West Virginia and a dozen other states, it claims the law is an attempt at a complete takeover of state finances.

(Adds detail of Missouri opinion in ninth paragraph.)

To contact the reporters on this story: Sam McQuillan in Washington at smcquillan@bloomberglaw.com; Donna Borak in New Jersey at dborak@bloombergindustry.com

To contact the editors responsible for this story: Jeff Harrington at jharrington@bloombergindustry.com; Kathy Larsen at klarsen@bloombergtax.com

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