Justice Department Defends Tax Mandate Provision in Covid Relief Bill

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In a court filing, the department responded to a lawsuit filed by Ohio’s attorney general, who said the tax mandate was unconstitutional and encroached on his state’s financial decisions.

States that use federal funds allocated under the American Rescue Plan to cut taxes would only be required to repay the amount used to offset reductions to their net tax revenue—not forego the entire grant amount—the Justice Department wrote in a recent court filing.

The filing represents the Biden administration’s first legal defense of a provision Congress inserted into the most recent coronavirus relief bill, that prohibits states from using coronavirus relief funds to offset tax cuts.

Justice Department attorneys were responding to a lawsuit filed by Ohio Attorney General Dave Yost, who has called the tax mandate unconstitutional and argued that it encroaches on his state’s autonomy over financial decisions.

“Ohio mistakenly assumes that the rescue plan requires a state receiving federal funds to freeze its existing tax laws in place and refrain from reducing any taxes,” wrote Justice Department attorneys in opposition to Ohio’s motion for a temporary injunction filed Friday. 

The coronavirus relief bill appropriates $195 billion in direct aid for state governments, but includes some restrictions on how the funding can be used. Several states, including Ohio, have challenged the legality of the tax mandate, which restricts states from using the funds “to either directly or indirectly offset a reduction in the net tax revenue” that stems from policy changes that would reduce taxes.

The Treasury Department, which is overseeing the administration of the state and local funding, has promised to release guidance related to the tax mandate before the aid is made available to states. In the meantime, the Justice Department filing provided more clarity on how the Treasury Department intends to enforce the tax mandate.

A state can impose whatever taxes it believes are appropriate with no effect on the amount of direct aid it receives, so long as the changes “taken together over the reporting period—do not result in a reduction to the state’s net tax revenue,” Justice Department attorneys wrote in the 39-page filing.

“A state is also free to lower its net tax revenue, as long as it does not use the rescue plan funds to offset—pay for—that reduction,” the Justice Department attorneys wrote.  If a state does cut taxes and uses the new federal funding to offset those reductions, “the consequence is proportional to the misuse.”

“The state will be required to repay only the portion of the federal money it used to offset the reduction in net tax revenue (not to exceed the amount of the federal grant),” the Justice Department wrote.

In addition to Ohio, the attorneys general of Tennessee and Kentucky filed lawsuits challenging the tax mandate. A coalition of 21 Republican attorneys general also wrote to Treasury Secretary Janet Yellen to ask her to provide further guidance on the tax mandate.

Ohio would receive about $5.5 billion in direct aid under the rescue plan. Yost argued that the tax mandate requires states to choose between either badly needed federal funding or their sovereign authority to set state tax policy.

The Justice Department, meanwhile, said in the court filing that Ohio’s case should be thrown out because the state has not indicated how it intends to use the federal relief funding, let alone how its use of the money would be inconsistent with the stipulations included in the law.

Attorneys cited a 1985 Supreme Court ruling involving Title I school funding as one example that Congress has the authority to require states to use federal funding for certain purposes without supplanting state and local expenditures.

“Provisions that require states to maintain their existing fiscal efforts as a condition of receiving federal funds are an uncontroversial and familiar exercise of Congress’s spending power,” the Justice Department attorneys wrote.

Andrea Noble is a staff correspondent with Route Fifty.

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