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Feds Fight Arizona's Bid To Block Limits On Tax Cuts

By James Nani · May 3, 2021, 6:28 PM EDT

Arizona's push to stop the U.S. Treasury from enforcing part of the March coronavirus relief law that could allow the government to withhold funds from states that lower their taxes should be rejected, Treasury told a federal court.

Congress was well within its powers to pass the so-called tax mandate portion of the American Rescue Plan Act , the Treasury Department told the court Friday. While Congress gave states flexibility in spending the roughly $350 billion in pandemic relief funds, it's allowed to make sure those funds can't offset reductions in net tax revenue from changes to state law, the federal government said.

"That is a straightforward exercise of Congress' well-settled spending clause authority to attach conditions that 'preserve its control over the use of federal funds,'" the federal government said.

Arizona Attorney General Mark Brnovich sued Treasury Secretary Janet Yellen and others in March, asking the federal court in Arizona for a preliminary injunction against the so-called clawback provision. The provision bars states from "directly or indirectly" using the coronavirus aid to offset a reduction in net revenue; otherwise, they risk having to return the amount that is used to offset a tax cut. 

Arizona has argued the mandate threatens state sovereignty by potentially encroaching on its ability to craft its own state tax policies, a "federal usurpation" that's "unprecedented" and violates states' rights under the 10th Amendment of the U.S. Constitution. The law is also ambiguous because it doesn't give clear notice of the meaning of "indirectly offset a reduction in the net tax revenue," the state has said.

But Treasury, represented by the Department of Justice, told the court that Arizona hasn't shown an actual concrete and particularized injury that's imminent, as required under Article III of the Constitution. Arizona's injuries are "hypothetical and speculative" guesses because it hasn't alleged it's enacted any tax cuts that would trigger the tax mandate provision or shown it plans to use the funds in such a manner, the response said. Tax cut proposals by the Arizona Legislature don't meet requirements for pre-enforcement standing, the response said.

"No state has a sovereign interest in using federal funds distributed under the Rescue Plan to offset a reduction in net tax revenue," the response said. "And Arizona, of course, retains the freedom to decline the funds."

In addition, Arizona isn't likely to succeed on the merits of its case because it hasn't met the "heavy burden" of showing the offset provision is unconstitutional in all applications , the federal government argued. The law gives clear notice of the funding condition and isn't coercive, and Congress validly exercised its power under the spending clause to restrict how the funds are spent, the response said.

The response notes that the provision applies only when a state uses the federal funds to offset a reduction in net tax revenue and that it wouldn't apply if tax cuts were balanced with increases in other taxes. The federal government noted that Congress' power to require states to maintain spending to secure federal funds has been upheld in U.S. Supreme Court cases involving education special education , Medicaid spending and temporary aid to low-income families .

"The offset provision is, by any measure, a modest restriction on an otherwise generous outlay of federal funds," Treasury said.

In order to avoid ambiguity, Congress also wasn't required to list every instance in which a state may fail to comply with the provision, the federal government said. The case is also distinct from National Federation of Independent Business v. Sebelius  because the coronavirus funds are new, unallocated money, Treasury argued. The Sebelius case dealt with the loss of preexisting Medicaid funding unless states agreed to expand Medicaid coverage.

Finally, the federal government said the public interest and the balance of harms weigh in favor of rejecting the preliminary injunction, arguing Arizona could accept the funds, use them to offset net tax revenue and still have a legal remedy via the courts.

"That potential recoupment action is where the state should make its arguments. With such action nowhere in sight, Arizona's challenge is premature," the response said.

Treasury has also argued that other states challenging the law, such as Ohio and Missouri, lack standing to bring claims similar to those Brnovich has lodged. Arizona's challenge has won support from national business groups, which asked the court to side with Arizona last month.

Representatives of Treasury and the Department of Justice didn't immediately respond to requests for comment Monday.

Brnovich's office didn't immediately respond to requests for comment.

Arizona is represented by Attorney General Mark Brnovich and by Joseph A. Kanefield, Brunn W. Roysden III, Robert John Makar and Drew C. Ensign of the Arizona Attorney General's Office.

Treasury is represented by Stephen Ehrlich and Charles E.T. Roberts of the U.S. Department of Justice.

The case is Arizona v. Janet Yellen et al., case number 2:21-cv-00514, in the U.S. District Court for the District of Arizona.

--Additional reporting by Dylan Moroses, Paul Williams, Abraham Gross, Maria Koklanaris and Andrew Kragie. Editing by Robert Rudinger.

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