Treasury Clears States to Cut Taxes -- But Not With Stimulus

The Biden administration said in a response to concerns raised by Republicans that state governments accepting pandemic-relief money from Washington are allowed to cut taxes, but only if they don’t use the federal aid to offset those reductions.

The Treasury Department’s statement addresses a provision in the recently enacted $1.9 trillion stimulus law that provided more than $360 billion in aid to states and cities. The measure said states couldn’t use the money to pay for net revenue reductions through 2024.

The law does not prohibit states from cutting taxes nor does it mandate them to return the funding if a state reduces levies, a Treasury spokesperson said in an emailed statement. States must replace that revenue from those tax reductions using other money in their budget, the Treasury said. If states did use relief-fund money to pay for a tax cut, then they could be required to reimburse the federal government for that, the department said.

The response addresses a growing concern, particularly among politicians from Republican-led states, that accepting federal-rescue funds would prohibit them from reducing taxes through 2024. Uncertainty about the restrictions on the funds prompted Oklahoma Attorney General Mike Hunter and 20 other state attorneys general to send a letter to Treasury Secretary Janet Yellen earlier this week asking her to clarify whether the provision strips states of their “core sovereign authority to enact and implement basic tax policy.”

Asked during a phone briefing Thursday how the Treasury will enforce the law if states shift money within their budgets, department officials said the agency is in the process of crafting rules that will explain how the restrictions work.

On Wednesday, Ohio sued the Biden administration over the provision, claiming the rule illegally restricts the state’s power to change its tax structure and economic policy. Ohio Attorney General Dave Yost said the last-minute addition by Senate Majority Leader Chuck Schumer holds hostage the $195 billion portion of the money for states.

Seeking Guidance

Several House Republicans have also sent a letter to Yellen asking her to advise on whether various forms of tax relief, including making unemployment benefits tax exempt or issuing state-wide stimulus checks, would violate the rules in the stimulus bill.

Republicans say the issue needs to be resolved in relatively short order. The law gives the Treasury Department 60 days to establish the fund, release the rules and distribute the funding. Most state legislatures only meet part time. Many are in session now, but adjourn in late spring or early summer.

The aid to states was a point of contention during debate on the stimulus. Republicans objected to including the money, arguing that it would serve as a bailout for Democratic-run states that had mismanaged their budgets and that many states hadn’t suffered severe revenue shortfalls as a result of the pandemic.

The provision added by Schumer was intended to focus the money on where it’s needed most, by targeting it based on state population and unemployment levels. It bars states from “either directly or indirectly” using the funds to offset a reduction in tax revenue “resulting from a change in law, regulation, or administrative interpretation.”

Democrats say the provision was a necessary guardrail to prevent states from using federal money to finance tax cuts. Schumer has said governors should use the money to focus on ending the pandemic, including on public health and social-assistance programs.

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