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Confusion over the tax mandate embedded in the $350 billion direct aid program for states and localities led Kentucky and Tennessee to file suit.
Opposition is heating up against the Biden administration’s prohibition on states using coronavirus relief funds to cut taxes.
Two additional states, Tennessee and Kentucky, filed a lawsuit this week challenging the restrictions on how they can use direct aid allocated to states through the American Rescue Plan. Ohio previously filed litigation challenging the restrictions.
Attorneys general for the two states called the tax restriction “an unprecedented power grab by the federal government.”
“Once a state accepts financial aid under the act—aid that might range from 20 to 40% of the state’s total annual revenue—that state is prohibited from setting its own tax policy if doing so will cause a net decrease in tax revenue,” wrote Tennessee Attorney General Herbert Slatery III and Kentucky Attorney General Daniel Cameron in a complaint filed in federal court. “Congress, in other words, is using the carrot of enormous financial aid to outright prohibit the states from lowering taxes on their own residents.”
The $1.9 trillion American Rescue Plan includes $350 billion in direct funding for state, local, tribal and territorial governments. Tennessee expects to receive about $3.7 billion under the rescue act and Kentucky expects to receive about $2.4 billion, the attorneys general said.
The law includes several restrictions on how states can spend the money, but the provision stirring up the most controversy says states shall not use the funds “to either directly or indirectly offset a reduction in the net tax revenue” that stems from policy changes that would reduce taxes.
A coalition of Republican attorneys general wrote to Treasury Secretary Janet Yellen to ask her to provide further guidance on the tax mandate, noting that the language included in the act “could be read to deny States the ability to cut taxes in any manner whatsoever.”
Yellen issued a response, saying that “nothing in the act prevents States from enacting a broad variety of tax cuts.” Rather, she said, the law says that funding cannot be used to offset a reduction in net tax revenue.
“If states lower certain taxes but do not use funds under the act to offset those cuts—for example, by replacing the lost revenue through other means—the limitation in the act is not implicated,” Yellen wrote.
The Tennessee and Kentucky attorneys general said the Treasury Department’s response “did not provide clarity about using relief funds to ‘indirectly’ offset a reduction in tax revenue.”
In the complaint, the attorneys general cited specific actions their state legislatures have taken this year that they worry could be called into question by under the tax mandate provision. Kentucky lawmakers passed a tax increment financing plan that would allow homeowners in a disadvantaged minority area to pay the current rate of property taxes on their homes for the next 20 years. A Tennessee bill still under consideration seeks to eliminate the state’s professional privilege tax as a way to attract new businesses to the state.
The Treasury Department intends to release further guidance related to the tax mandate in order to address the concerns raised by GOP lawmakers. Yellen said the department plans to provide that guidance before states are required to provide certifications in order to receive the latest round of Covid aid.
Andrea Noble is a staff correspondent with Route Fifty.