New state COVID aid dollars may have confusing strings attached

The American Rescue Plan Act (ARPA) of 2021 will provide more than $500 billion of aid to state and local governments. Much of this money will go to state and local governments that have already seen their revenues recover from last year’s recession.

Because some states are currently posting revenue surpluses, they may be encouraged to spend this additional, one-time money in counterproductive or ineffective ways.

Nebraska will likely receive roughly $3 billion provided by Congress through the ARPA to a number of budget areas (e.g., public schools, transit authorities, state and local governments, etc.). Nebraska governments are expecting to receive $1.1 billion at the state level and $667 million for local governments such as cities and counties.

Overall, ARPA allows greater flexibility in how these funds may be used than in last year’s original CARES Act. However, ARPA also contains some restrictions on how state and local governments can use these funds through December 31, 2024, and failing to follow those rules can result in the aid being clawed back by the federal government. The bill language related to these restrictions is highly ambiguous at times. Specifically, on page 579,

‘‘(A) IN GENERAL.—A State or territory shall not use the funds provided under this section or transferred pursuant to section 603(c)(4) to either directly or indirectly offset a reduction in the net tax revenue of such State or territory resulting from a change in law, regulation, or administrative interpretation during the covered period that reduces any tax (by providing for a reduction in a rate, a rebate, a deduction, a credit, or otherwise) or delays the imposition of any tax or tax increase.”

This language has caused confusion amongst many fiscal experts and attorneys specializing in state and federal finance issues. While there is a general understanding that Congress does not intend for governments to use ARPA funds to cut taxes or to fund pension debts, the above language may leave many wondering if accepting ARPA funds would prohibit states from taking other actions on tax policy for the next several years, including carrying out existing tax reductions or rebates.

The full details of this provision, and the entire ARPA, will not be clear until Treasury Secretary Janet Yellen issues the Treasury Guidance, or regulations, which are required to be published within 60 days of the bill being enacted into law.

Until then, states like Nebraska may have questions about whether accepting ARPA funds would mean being unable to carry out programs like LB1107 (a rebate and credit program), or to move ahead with more substantial tax modernization.

According to the Wall Street Journal,

“The language is so expansive that states could be limited from making any changes to their tax codes that reduce revenue even if they don’t use federal funds as direct offsets. Much will depend on how Ms. Yellen defines “indirectly.” States that don’t comply with her interpretation will have to repay federal funds.”

Others have pushed back saying restricting a state’s “indirect” activities for accepting federal funds becomes a constitutional question. The U.S. Supreme Court’s anti-commandeering doctrine is based on the 10^th Amendment. Essentially, this doctrine prohibits Congress from using federal funds to coerce states, but the doctrine has no basis in constitutional law, only in the court’s rulings. That means a broad interpretation of ARPA’s restrictions could become a legal matter for states.

Jared Walczak of the Tax Foundation, on the other hand, says that while the language of the bill is “messy,” the restrictions may not be overbearing for states.

I think this @WSJopinion editorial overstates the restrictions on state tax cuts imposed by the American Rescue Plan Act–it doesn’t go so far as to say that “they can’t change their tax laws” through 2024 if they use relief money–but it’s very messy.https://t.co/vJRFHM4w8V

— Jared Walczak (@JaredWalczak) March 10, 2021

Financially, Nebraska is in a good place. We have one of the lowest unemployment numbers in the nation, our state revenues are exceeding projections, and the revenue forecasting board just increased future revenue projections, lending to a stronger desire for tax reform.

While ARPA is noteworthy for providing a major amount of flexible aid to state and local governments, the specific restrictions that are mentioned in the bill might impact Nebraska’s ability to participate in the program in a fiscally responsible and effective way.

As with the CARES Act before it, there are likely to be many questions about ARPA’s intent and implementation. And, if the Treasury Department interprets the law too broadly, it may result in lawsuits, or have some state leaders wondering if the price of accepting the federal funds is too great.