Amidst the trillions of dollars the American Rescue Plan (ARP) Act threw at progressive pet projects that are scarcely related to the pandemic, an eleventh-hour change slipped in by Sen. Joe Manchin (D-WV) didn’t initially receive much attention.
In an effort to kneecap his home state’s tax reduction effort, he added a provision barring states from putting the $200 billion in state aid the ARP provides towards tax cuts. Since the bill was passed, it’s become clear that the provision could potentially prevent states from doing just about anything to reform their tax code.
The provision in question bars states from “directly or indirectly” using ARP state aid to offset policy changes that reduce net revenue. The word “indirectly” is what has created issues — since state budget dollars are fungible, federal aid to states could theoretically be offsetting anything that results in the state taking in less revenue.
Ironically, this provision is particularly consequential because of how excessive the amount of state aid was. While states once feared fiscal armageddon, the budget picture became much rosier for most by the time the ARP was passed. Part of the reason the Senate went ahead with inserting this provision was that multiple states, including Manchin’s home state of West Virginia, already had tax cut efforts underway prior to the passage of the ARP.
And it’s far more than just tax cut efforts that the ARP could potentially stifle. While the ARP exempted the first $10,200 in unemployment benefits (double that for married couples) from federal taxes, a strict reading of the ARP would suggest that states could not conform to that treatment without forfeiting their federal aid.
On a similar note, states could potentially find that they were not allowed to refill their depleted unemployment trust funds with federal aid. That would be particularly absurd, as this is one of the most responsible ways that states could go about using a one-time cash infusion from the federal government.
The ARP could have other unintuitive consequences. While New Hampshire and Massachusetts have been engaged in a legal battle over Massachusetts’s decision to tax remote-working New Hampshirites, Massachusetts may not be able to back down even if it wanted to (as doing so would reduce the state’s net revenue). Should the Supreme Court side with New Hampshire and force the Bay State to stop taxing out-of-state telecommuters, it could even potentially cost Massachusetts federal aid dollars.
In Maryland, efforts are underway to delay implementation of the state’s harmful digital advertising tax by a year. This too could cost Maryland federal aid dollars, as it would technically reduce the state’s expected revenue.
For its part, the Biden administration has tried to defuse the tension over this provision. In response to 21 state attorneys general seeking clarification over the provision, the Treasury Department stated that states could cut taxes so long as they did not use federal funds to do so.
Nevertheless, that hardly lays the issue to rest. What qualifies as a “net tax reduction” remains a matter of interpretation, as does “using federal funds to offset” said net tax reduction. Treasury Secretary Janet Yellen has promised further guidance soon, and it’s badly needed.
Fortunately for states, it’s rather clear that a strict interpretation of the ARP’s provision would not pass legal muster. While the federal government does have some latitude to impose restrictions on grants provided to states, such grants cannot coercively restrict states’ ability to set policy. Effectively preventing states from doing anything to reduce tax revenue would almost certainly qualify as an unconstitutional restriction on state sovereignty.
This episode will likely go down as a lesson on unintended consequences. While doubtless Sen. Manchin did not mean to force state and federal bureaucrats to spend days grappling with his poorly phrased provision, it will likely have the impact of delaying or even preventing needed tax reform efforts in the midst of a pandemic. That’s a huge cost for less than a hundred words of legislative language.
Andrew Wilford is a policy analyst with the National Taxpayers Union Foundation, a nonprofit dedicated to tax policy research and education at all levels of government.