Treasury issues guidance on Federal relief package and some of the rules might impact Nebraska

Treasury issues guidance on Federal relief package and some of the rules might impact Nebraska

The U.S. Treasury has issued guidance as a follow-up to the American Rescue Plan Act (ARPA) that was enacted by Congress on March 11, 2021.

As background, Congress enacted ARPA as a continuation of their previous relief packages to help the nation recover from the COVID-19 pandemic. In total, there was $350 billion spent for state and local governments. Below is a detailed breakout of what Nebraska received.

If you remember, this legislation has been the catalyst for multiple lawsuits and states questioning the constitutionality of a specific provision that prohibits directly or indirectly offsetting a state tax cut.

The good news is that this guidance does shed some clarity on some issues, the bad news is that now there are new questions arising that will need additional clarification. Treasury has identified a number of follow-up questions it is asking state governments for feedback.

Below are some of the things spelled out in the guidance that we know of and will (or could) have an impact in Nebraska. Specifically, I will be focusing on Section III of the guidance, which is titled “Restrictions of Use.”

States can enact tax cuts and the Treasury will recognize three sources of funds to offset a reduction in net tax revenue other than Fiscal Recovery Funds: (1) organic growth, (2) increases in revenue (such as an increase in a tax rate), and (3) certain cuts in spending. (page 82) If sufficient funds from these other sources are identified to cover the full cost of the reduction in net tax revenue, then it will not be considered a violation of ARPA.

All revenue measurements will use Fiscal Year 2019 as a baseline using the Bureau of Economic Analysis’ implicit price deflator to adjust the nominal dollars for subsequent years. This is good news for Nebraska since in FY 2019 the state collected $4.896 billion in revenue. According to BEA, the growth figure for 2020 was -3.5% and Nebraska collected more revenue at $4.940 billion, which means we have a safe harbor at the present time for changes to our revenue.

To ensure compliance by states, the Treasury is requiring each recipient government to report their actual tax revenue and identify and value any changes in law or regulation that would result in a net tax revenue reduction during the covered period (pgs. 83-84). This means the tax changes or any laws that alter the state’s revenue enacted this session will have to be sent to the U.S. Treasury along with the state’s actual tax collections at the end of the fiscal year.

There are, however, a few details to be aware of. If the change is below a 1% de minimus level, then it is exempt from having to identify funding sources to pay for the change (pg. 89). This would occur in the case of small technical corrections to a state’s tax code that have minimal impacts to revenue.

One detail that many fiscal analysts will want to know is that states are prohibited from using dynamic scoring for estimates of revenue losses from a tax change (pg. 89). Essentially, this means that there cannot be an assumption that a tax policy change will result in positive macroeconomic effects that will offset some of the revenue lost.

While the 151 page document has a number of details on what states can and cannot do, here are few more I want to highlight. According to a tweet from a TaxNotes reporter, states cannot use federal funds for new business tax incentives. Also, conformity to recent changes in the Internal Revenue Code will not count towards a net reduction in tax revenue even if they have that effect. (See Nebraska’s impact from ARPA here). However, decoupling was not specifically addressed or whether conformity needs to happen in aggregate.

Other ineligible uses were identified including funding debt service, legal settlements or judgements, deposits into rainy day funds or financial reserves, and general infrastructure spending outside of water, sewer, and broadband.

In closing, I want to address one small detail that may have a big impact for Nebraska. This guidance from Treasury imposes unprecedented oversight of state government finances, and the sooner Nebraska can get out from under the Federal government’s thumb, the better.

That said, the covered period for states lasts from March 3, 2021 through the last day of the fiscal year in which the funds provided have been spent, which means the faster Nebraska can spend this money, the faster the state can operate with fiscal autonomy again. It is no secret the state needs to modernize its tax code and having “Big Brother” watching over our shoulder will not make that process any easier.

Nebraska state lawmakers should make a goal to have all this money spent or sent back to the U.S. Treasury before June 30, 2022 to ensure the future Legislature and new governor are not saddled with events from the previous biennium.

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