Should Congress Set State Tax Policy As a Condition of Federal Recovery Aid?

Should Congress Set State Tax Policy As a Condition of Federal Recovery Aid?

How do you think that the Rhode Island General Assembly would react if future federal aid was linked to state and local tax policies determined in Washington and not in the Rhode Island State House?

The question of the relations of the states to the federal government, wrote Woodrow Wilson in 1908, “is the cardinal question of our constitutional system”. Matters of state and federal fiscal responsibility have been vexing to presidents, members of Congress, the courts, and state and local governing authorities since the founding of the nation.

The words Wilson spoke 113 years ago are particularly relevant today because the American Rescue Plan Act (ARP) -the $1.9 trillion federal COVID-19 relief program includes a provision that states and municipalities cannot use ARP funds to “directly or indirectly offset” tax reductions. At this point, it is unclear how this law will be applied. Treasury Secretary Janet Yellen told a Senate Committee, “We will have to define what it means to use money from this act as an offset for tax cuts, and given the fungibility of money, it’s a hard question to answer.”

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The ARP legislation distributes $350 billion to state and local governments. The program is an unparalleled and historic jolt for state and local budgets. This federal aid can be used until 2024 with almost no strings attached. This represents a long-needed paradigm shift from the federal “carrot and stick” approach to federal aid programs. Recovery fund dollars can be used to close budget gaps, respond to coronavirus health needs, build infrastructure and support nonprofit agencies. Most important this flexibility can support innovative state and local recovery projects

Furthermore, a substantial amount of funds goes directly to localities. Thus, our cities and towns are not required to go to the General Assembly for funding. The Brookings Institution commends this approach noting APR gives local governments “a chance to move beyond relief, and seed a new trajectory deploy the money smartly and equitably.”

Unfortunately, transferring key state tax policy powers from state legislatures to Washington as a quid pro quo for receiving recovery funds appears to be inconsistent with the principles of fiscal accountability and federalism.

The late William Anderson, a University of Minnesota political scientist and an Eisenhower appointee to the first Federal Commission on Intergovernmental Relations found that “There is no serious allegation that the United States Constitution puts unjustifiable restrictions upon state taxing powers.” The primary exception is that states cannot place unduly burdensome taxes on interstate commerce.

There are also fundamental questions of how the anti-tax cutting provision in the ARP will be interpreted and applied in all fifty states. Tax yields are the product of the tax rate times the tax base. If a state or city experiences growth in its tax base, can it reduce the rate if the amount the tax generates increases or stays the same? It will be interesting to see how Treasury writes transparent regulations about what types of tax rate changes are and are not permissible.

Fourteen states are challenging the APR tax-cut restriction in federal court.  The Wall Street Journal notes the following salient point in their brief, “The Supreme Court’s anti-commandeering doctrine puts strict limitations on how much Congress can lean on states to enact its favored policies.” It will be interesting to see if the courts' command states to adopt tax policy in the interest of Congress or based on state legislative judgments of tax competitiveness, fairness, and efficiency.

What goes around comes around. If progressives mandate that states forego tax cuts to receive federal recovery assistance, what is to stop a future conservative congress from limiting a state’s ability to raise taxes in order to be eligible to receive federal assistance?

In the long run, the principles of federalism should eclipse short-term partisanship.

 

Gary Sasse is the Founding Director of the Hassenfeld Institute for Public Leadership at Bryant University.