State leaders seek answers from Washington on tax modernization

State leaders seek answers from Washington on tax modernization

Just days after the American Rescue Plan Act (ARPA) passed both houses of Congress and was singed into law by President Biden, many started questioning various provisions in the legislation.  The one that has given the most pause is the provision that says states cannot cut taxes if they take relief money.

A group of state attorneys general sent a letter to U.S. Treasury Secretary Janet Yellen voicing their concerns. The following day, a Treasury Department spokesperson told the Associated Press the provision was not meant as a blanket prohibition on tax cuts.

According to the news story the Treasury Department said, “States are free to make policy decisions to cut taxes – they just cannot use the pandemic relief funds to pay for those tax cuts.” Nebraska Gov. Pete Ricketts commented, saying he feels confident with the state’s current revenue situation that Nebraska can move forward with tax changes and not be hindered by the provision in ARPA.

However, the future of Nebraska tax cuts and tax modernization efforts are not completely in the clear….yet.

The Tax Foundation has evaluated ARPA at length and has come up with a list of questions that need to be answered by the Treasury Department’s guidance for state’s to have a clear message of what is allowed and how to proceed with tax changes. According to Jared Walczak, Vice President of State Projects, some of the tax issues that could “run afoul the prohibition” that would directly affect Nebraska’s tax efforts are:

  • Tinkering with sales tax exemptions;
  • Adjusting tax incentives;
  • Offsetting local property tax burdens; or
  • Expanding the earned income tax credit (EITC).

For 100% clarity, the Treasury Department needs to answer the following questions:

  1. What constitutes a net tax reduction?
  2. How is a net tax reduction determined to have resulted from a policy change?
  3. Which potential expenditures could be deemed to create fiscal capacity for a net tax cut?
  4. How would offsetting a tax reduction be defined, especially across multiple years?

Even Nebraska’s head Legislative Fiscal Analyst, Tom Berquist, said things might get tricky if Nebraska cuts taxes and then later uses the federal funds to “backfill” a reduction in state revenue.

The provision in ARPA lasts until December 31, 2024. If the tax changes the state is considering this year–which includes phasing out state income tax on Social Security benefits and fully exempting tax on military pensions–is paired with a downturn in the economy (which many are predicting), the state might find itself in a position in 2023 to need to backfill revenue.

That is why the Platte Institute joined a group of 40 organizations across 25 states and Washington, D.C. to ask Secretary Yellen to interpret the ARPA legislation in a way that does not “unconstitutionally tie the hands of state governments in their work, creating and implementing the tax and spending plans for their sovereign states.”

See the coalition letter here: State Think Tank Letter to Secretary Janet Yellen

Want more? Get stories like this delivered straight to your inbox.

Thank you, we'll keep you informed!