Kansas' Derek Schmidt was one of 21 Republican attorneys general who sent a letter to Treasury Secretary Janet Yellen that provisions in the American Rescue Plan Act shouldn't be used to limit states' powers to cut taxes. (AP Photo/John Hanna)
The letter addresses a federal provision that prohibits states from using the recent $350 billion cash infusion to states "directly or indirectly offset … [states'] net tax revenue" via state laws, regulations or through rate cuts, rebates, deductions, credits "or otherwise." States that don't comply with the provisions would be required to repay funds equal to the amount of tax cuts they gave, the letter said.
"Such federal usurpation of state tax policy would represent the greatest attempted invasion of state sovereignty by Congress in the history of our republic," the letter said.
The attorneys general argued that the provisions could be read to deny states the ability to cut taxes even if they gave tax cuts without the possibility of the coronavirus pandemic funds.
The letter lists several state proposals that the provision could waylay, including an Arizona legislative proposal that would create an alternative income tax to help certain businesses bypass a potential 3.5% income tax surcharge on the state's highest earners.
Beyond policy disagreements, the letter argues that a broader interpretation of the statute would unconstitutionally infringe on state sovereignty, citing U.S. Supreme Court decisions from 1987 and 2012 that limit federal mandates that could be so coercive they're essentially required.
If interpreted broadly, the state attorneys general said the provision would be "hopelessly ambiguous," and wouldn't relate to the federal interest the funding was meant for. In addition, a broader interpretation would violate separation of powers principles, "fundamental democratic principles" and allow governors, in accepting federal funds, to limit the power of state legislatures or successive governors.
Not all state GOP attorneys general were content to wait for Treasury to act. Ohio Attorney General Dave Yost filed a motion for preliminary injunction Wednesday in the U.S. District Court of Southern Ohio against the provision, arguing it exceeds Congress's authority. The offices of Republican attorneys general from New Hampshire, Tennessee and North Dakota, who also didn't sign the letter, didn't immediately respond to requests for comment.
Stephen Kranz, tax partner at McDermott Will & Emery LLP, told Law360 the provision has frozen some tax policy decisions and noted that he and others at his firm have been asked to evaluate whether taxpayers have a private right of action against the provision.
"Legislation that everyone thought was going to be passed has been stalled by people who were never elected to serve in the Legislature," Kranz said. "And so do taxpayers have some type of right of action is a question that we're exploring right now."
Amanda Critchfield, a spokeswoman for U.S. Senate Finance Committee ranking member, Sen. Mike Crapo, R-Idaho, told Law360 that Crapo filed an amendment to strike the provision while the bill was being considered in the Senate, but it didn't receive a vote. Crapo introduced identical standalone legislation this week to repeal the section and sent a list of questions to Yellen on Tuesday asking how the provision will be implemented.
U.S. House Republican leaders, including Rep. Kevin Brady, R-Texas, the ranking member on the Ways and Means Committee, issued their own letter and questions to Yellen on Wednesday, asking for clarification and guidance on the provision and requesting a reply by March 26.
Richard Pomp, a tax professor at the University of Connecticut School of Law, said Congress should have the right to view its grant as a relief measure for costs imposed on states by the pandemic. He noted that states that can cut taxes aren't the intended recipients of the grant.
"They are displaying evidence of not needing the funds, so why should Congress waste its money?" Pomp said. "If this condition has the incidental effect of prohibiting tax incentives for economic development, it will have accomplished what so many commentators have been wishing for."
But Karl Frieden, vice president and general counsel at the Council on State Taxation, said the language of the statute is "extremely broad and somewhat unprecedented." If the Treasury interprets the statute to restrict measures such as previously passed tax cuts by states, increases in the tax base or policy changes unconnected to the federal aid, Frieden said that would be "disturbing." He noted the provision is within a section that generally says the federal funds are supposed to be used for the purposes that are designated.
Daniel Hemel of the University of Chicago Law School said despite what he called "over-the-top rhetoric" of the letter, the attorneys general had a point that the law section if interpreted very expansively would mark a "substantial intrusion" into state tax policymaking. He expected Treasury would advance a narrow interpretation of the section that allows states discretion to cut taxes if they choose.
"I'd prefer that states with surpluses use that money to make investments in education and public health or to shore up pension systems, but I don't think Congress can really stop states from cutting taxes if they want," Hemel said.
The offices of federal congressional leaders and Treasury didn't immediately respond to requests for comment.
--Additional reporting by Maria Koklanaris and Andrew Kragie. Editing by Neil Cohen.
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