States Should Choose Tax Cuts Over Federal Bailouts

Don't take the money.

Ohio is in many ways a perfect example of why a federal bailout of states was hardly necessary—and now it will become the focus of a legal battle over a federal power-grab hidden inside that bailout.

Last year, as the COVID-19 pandemic was accelerating and the U.S. economy was being locked down, Republican Gov. Mike DeWine said the state might have to drain its entire $2.7 billion rainy day fund to offset expected revenue losses. By this spring, however, things were looking much less bleak. Thanks to some wise spending reductions and a less-severe-than-anticipated revenue decline due to COVID, the state now seems likely to emerge from the pandemic without touching the rainy day fund at all.

The story is pretty similar in most states. Overall, state tax revenue declined by less than 0.1 percent last year, and billions of dollars in federal aid distributed to states remain unspent. Still, Ohio is set to receive more than $5.5 billion—twice as much money as is sitting in the state's untapped rainy day fund—from the American Rescue Plan (ARP), which President Joe Biden signed into law earlier this month.

To get it, all Ohio has to do is trade away control over tax policy for the next few years. States that accept the federal bailout are prohibited from using the money to "directly or indirectly offset a reduction in the net tax revenue" from policy changes between now and 2024. It's a provision that is both vague enough and potentially broad enough to block states from cutting taxes or making changes to tax credit programs without first getting permission from the federal government.

That "coercive" provision of the ARP "allows Congress to quietly impose its preferred tax policies without having to pay the full political price for doing so," argues Ohio Attorney General Dave Yost in a lawsuit filed in federal court last week. Other states are likely to join the lawsuit. Already, 21 Republican attorneys general signed a letter to Treasury Secretary Janet Yellen last week objecting to what they called "an unprecedented and unconstitutional intrusion" on state sovereignty.

Republicans' objections to the ARP's federal power-grab have merit, but they probably overstate the degree to which the federal money should be considered coercive.

The federal government is allowed to attach strings to grants provided to state governments (and it routinely does so). But the Supreme Court has held that such restrictions must be "unambiguous." In contrast, the ARP's state tax provision is incredibly ambiguous and is made more so by the fact that money is fungible.

"That prohibition on indirectly offsetting a state tax cut is extremely vague and potentially quite expansive," writes Jared Walczak, vice president of state projects at The Tax Foundation, a nonpartisan tax policy think tank. "It is very difficult to be sure what sort of uses of state aid might be interpreted as indirectly offsetting a net tax cut, even if the state had the resources to cut taxes in the absence of the federal assistance."

The Treasury Department will draw up its own guidance and enforcement rules, but the courts should be skeptical of laws that grant the executive branch such potentially broad power over state policy. And the courts historically have done so, including striking down the Trump administration's attempt to block federal grants to so-called "sanctuary cities" and blocking the part of the Affordable Care Act that required states to expand Medicaid eligibility in order to continue receiving federal funding for the program.

"If the executive can use vague statutes to impose its own grant conditions on state governments, it would give the president dangerous leverage to pressure the states and usurp Congress' power of the purse, thereby undermining both federalism and the separation of powers," writes Ilya Somin, a law professor at George Mason University.

The ARP's state tax provision seems to be a poorly written policy that rests on shaky constitutional and legal grounds. But Ohio's claim of undue federal coercion is more than a bit disingenuous.

"The Tax Mandate thus gives the States a choice: they can have either the badly needed federal funds or their sovereign authority to set state tax policy," lawyers for the state argue in their lawsuit challenging the ARP. "But they cannot have both. In our current economic crisis, that is no choice at all."

That's overstating things. Unlike, for example, the Affordable Care Act's attempt to arm-twist states into expanding Medicaid by threatening to hold hostage an already-existing and ongoing stream of federal funding, the bailout contained in the ARP is a one-time cash infusion that most states, including Ohio, don't need. In objecting to the string attached to the bailout, Ohio's lawyers are overtly asking federal courts to let the state have the money without the objectionable conditions. Instead, state lawmakers should just say no to the federal funds.

Of course, that should not excuse Congress for including an overly broad and probably unconstitutional provision in the ARP. But the best way for states to maintain control over their sovereignty is for them to assert responsibility for their own budgets by rejecting unneeded federal aid.