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Ooh, Treasury regs interpreting the ARP rule that state and local governments cannot use federal aid to cut taxes are out. TLDR: They are *very* sensible, responding to the federal interest in avoiding future bailouts while respecting federalism concerns https://home.treasury.gov/system/files/136/FRF-Interim-Final-Rule.pdf
This is going to be a long thread!
Some background: ARP state aid can be for public health, to replace lost tax revenue, offset the pandemic’s negative economic effects, or invest in infrastructure.
But states can’t use ARP money to fund tax cuts or contributions to their public employee pension plans. https://www.taxpolicycenter.org/taxvox/big-stakes-treasurys-american-rescue-plan-state-tax-cut-guidance
The tax provision also includes an anti-evasion rule: A State or territory shall not use the funds provided … to either **directly or indirectly** offset a reduction in the net tax revenue ...resulting from a change in law, regulation, ...… https://www.congress.gov/bill/117th-congress/house-bill/1319/text
Some theory: Federal aid to states everywhere and always involves greater federal involvement in state budgeting. Why? Absent some check, federal aid creates a “soft budget constraint…” https://www.amazon.com/Hamiltons-Paradox-Federalism-Cambridge-Comparative/dp/0521842697
That is, if the feds provide states with aid during economic downtowns with no limits and no monitoring, it is creating conditions for moral hazard, as states will now budget knowing the future is likely to have more federal aid.
Using the money for tax cuts particularly can create problems in out years, as tax cuts are generally permanent. The limitations on what state aid in ARP can be used for generally are designed to bring spending forward, not to encourage the creation of huge future liabilities….
OTOH, the federal law has been challenged on federalism grounds by a variety of state AGs. Here’s the big one https://www.scribd.com/document/503112950/Ohio-v-Yellen
The Treasury Regs are true to the spirit of the legislation – banning the indirect use of ARP money for tax cuts – but respect state government’s tax policy independence
They require states to tell the federal government about tax cuts, but do not block state tax cuts if a state’s total revenue is higher than 2019 (a pre-Coronavirus baseline). OR tax cuts can be offset by (a) real spending cuts; (b) other tax changes or (c) economic growth
It seems that the only way a state could fall afoul of this is if they aggressively cut taxes below the 2019 budget year baseline without taking any offsetting steps or doing so in response to real economic changes.
States generally have balanced budget requirements (details vary by state) and this fits with those, not standing in the way of any tax cuts that would comply with balanced budget rules unless the budget would not balance with ARP aid
That is, unless states use the federal aid in a way that suggests that the federal aid has created a soft budget constraint, their tax cuts are fine.
The federal government has a real interest in federal dollars not creating a sugar high in state budgets in ways that lead to state budgets being in the type of shape that they require future bailouts.
The regs are responsive to that federal interest, while also being respectful of state interests. Good stuff.
May be of interest to @marywalshnyt @JoeMysak @willwilkinson @hamandcheese @mattyglesias @reihan @bchapatta @WGlasgall @BCAppelbaum @jbarro @noamscheiber @heather @VolckerAlliance @michael_hendrix @EjmEj @noahopinion,
