The Volokh Conspiracy

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New Developments in Ohio's Challenge to the Stimulus Bill Provision Restricting Tax Cuts by States Receiving Federal Grants under the Act

A federal court issues a ruling against the requirement that states receiving stimulus funds are not allowed to raise taxes. Meanwhile, the Treasury Department issues an "interim final rule" intended to limit the scope of the mandate - and protect it against legal challenge.


As co-blogger Josh Blackman notes, yesterday federal district Judge Douglas Cole issued a ruling holding that the state of Ohio has "a substantial likelihood of success" in its effort to challenge a provision of the March 2021 stimulus bill that bars states receiving federal grants under act from lowering taxes until the end of 2024.  He also denied Ohio's motion for a preliminary injunction blocking enforcement of the  condition (primarily because the Treasury Department hasn't actually done anything to enforce it and is unlikely to do so anytime soon).

Meanwhile, just two days before the ruling, the Treasury Department issued an Interim Final Rule interpreting the Act, including the tax provision. As we shall see, that rule significantly narrows the potential scope of the condition, and seems designed to insulate it from legal challenge. It's a very reasonable policy. But it fails to fix the single most significant legal vulnerability of Section 602: the fact that Congress didn't even come close to making clear what exactly the rule means. That flaw can't be fixed by the executive branch, after the fact.

I. The Constitutional Problem with the Tax Condition

Section 602(c)(2)(A) of the American Rescue Plan Act (ARPA) states that:

A State or territory shall not use the funds provided under this section or transferred pursuant to section 603(c)(4) to either directly or indirectly offset a reduction in the net tax revenue of such State or territory resulting from a change in law, regulation, or administrative interpretation during the covered period [from now till December 31, 2024] that reduces any tax (by providing for a reduction in a rate, a rebate, a deduction, a credit, or otherwise) or delays the imposition of any tax or tax increase.

Ohio has filed a lawsuit claiming that this provision is unconstitutional because it violates two longstanding constraints on conditions attached to federal grants to state governments. First, Congress failed to make the nature of the condition "unambiguously" clear, as required by Supreme Court cases such as  Pennhurst v. Halderman (1981), and South Dakota v. Dole (1987). Second, the amount of money involved (some $350 billion) is so large that the condition becomes "coercive," thereby running afoul of the a different set of Supreme Court precedents, most notably NFIB v. Sebelius (2012).

As I explained in my earlier post on this case, the ambiguity issue is the biggest problem for defenders of the law. The text leaves several key points unclear, including 1) how we calculate whether a tax cut causes "a reduction in the net tax revenue," 2) whether it applies to previously enacted tax cuts that only take effect during the covered period,  and 3) whether, if a state violates the condition, it stands to lose all of its ARPA grant money or only the part "offset" by the "reduction in net tax revenue."

Judge Cole zeroes in on this problem in his ruling:

Despite poring over this statutory language, the Court cannot fathom what it would mean to "indirectly offset a reduction in the net tax revenue" of a State, by a "change in law … that reduces any tax (by providing for a reduction in a rate, a rebate, a deduction, a credit, or otherwise)…."

[W]here things get hopelessly muddled is with regard to "indirectly" and "net tax revenue of such State." Start with the latter phrase. Net tax revenue as measured against the previous fiscal year? Or against what would have been collected without the change in taxes? Or what? And, in either event, how does one "score" the issue? In other words, let's say a State elects to increase its statewide sales tax, but decrease its income tax. Or a State opts to change how progressive its income tax rates are. Does that effect a reduction in "net tax revenue"? After all, the State may enact the package of tax changes (or even a single tax change) thinking that the State will collect more taxes as a result, but may simply be wrong….

That on its own would be bad enough, but the ARPA then lumps "indirectly
offset" on top. The Court honestly has no idea what an "indirect offset" to net tax
revenues may be. It became clear at oral argument that the federal government was
largely unwilling to hazard a guess as to what it meant either.

It's blatantly obvious that these are ambiguities. And they are important ones, not just small niggling details.  As Judge Cole notes, the problem cannot be fixed by arguing, as the Biden administration did, that "the Spending Clause does not require that the substance of the conditions be clear, but merely that the statute make clear that conditions exist." That, he correctly notes, runs counter to Supreme Court precedent.

II. Can the Treasury Department Fix it?

However, as Judge Cole notes, the government does have one last ace up its sleeve: perhaps the ambiguity can be fixed by the Interim Final Rule issued by the Treasury Department just two days before his ruling. Unlike the statutory text, this rule is admirably clear. Yale Law School Prof. David Schleicher, a leading academic expert on fiscal federalism issues, has a helpful summary on Twitter:

[The Treasury Deparment rules] 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.

David is absolutely right to suggest these rules are clear. I think he also puts forward a strong policy rationale for them: they maintain a substantial degree of state autonomy, while reducing the moral hazard created federal subsidies.

I would add that the rules also indicate that "[a] recipient government will not be required to repay to the Treasury an amount that is greater than the recipient government's actual tax revenue shortfall relative to the baseline (i.e., fiscal year 2019 tax revenue adjusted for inflation)." This greatly reduces the amount of money at stake for the states, and probably knocks out any possibility that the condition would be ruled "coercive," as that concept has been interpreted by the Supreme Court in NFIB v. Sebelius.

If these rules were actually in the text of the statute, Ohio's lawsuit would likely be doomed to failure. The problem is that the Treasury rules, no matter how sensible, are not actually in the statute. As Judge Cole puts it:

[I]t is not at all clear that the [Treasury] Secretary can ever cure a Spending Clause ambiguity program, even through final regulations. As noted above, it may be the case that, because the Spending Clause is an Article I [legislative] power, it is Congress, not Executive Branch officials, that must provide the requisite clarity.

To my mind, there is no "may be" about it. As the Supreme Court explained in  the 1981 Pennhurst decision—the leading precedent on the subject—" if Congress intends to impose a condition on the grant of federal moneys, it must do so unambiguously" (emphasis added). Moreover, over the last four years, a whole series of lower court decisions joined by both conservative and liberal judges invalidated various Trump Administration efforts to pressure sanctuary cities by exploiting vague statutory language to attach immigration enforcement conditions to various federal grants. Courts repeatedly ruled that any such conditions must be set by Congress, not the executive. Because of that, Trump lost almost all of these cases (with one significant aberrational exception).  The Biden administration's interpretation of the tax condition has similar flaws.

Given the narrowness of the Treasury Department's conditions, one might ask what would be the harm of upholding them? Most states would suffer little or no constraint on their power to cut taxes. And, for reasons explained by David Schleicher, the Treasury's version of the condition makes good policy sense (assuming we have to have the ARPA grants at all, which I doubt).

Purely legal considerations aside, the problem is that, if courts uphold these executive-created conditions, it would open the door to other executive-branch efforts to use vague statutes to make up their own conditions in order to pressure states and localities to do the White House's bidding. The Trump administration's shenanigans in the sanctuary cities cases are a good example of the kind of thing that can happen. In addition, such broad delegation of spending authority to the executive branch undermines the separation of powers, and increases the already dangerous centralization of power in the White House. What I wrote about the broader stakes in the sanctuary cities cases also applies here:

If the president can unilaterally add new conditions to one federal grant program, he can do the same with others.

Since there is a vast array of federal grants, that would give the executive a massive club to coerce states and localities on a wide range of issues. Conservatives may cheer when the current administration uses this tool against sanctuary cities, but will likely regret their enthusiasm if a liberal Democratic president uses the same tactic to force states to pursue left-wing policies.

Exploiting vague statutory language is one way for the executive to make up its own conditions—one nearly as dangerous as simply making up conditions out of whole cloth. Given the vast number of federal grant laws out there, there are plenty of opportunities to exploit vagueness in that way.

The tax condition case may make some conservatives belatedly happy that the Trump administration got pummeled in the sanctuary cities cases. By the same token, liberals should be wary of giving the next Republican administration the kind of power it would have if the Biden manages to win the tax mandate case.

Yesterday's ruling is far from a final resolution of the case. It is not yet even a final ruling by the district court. While emphasizing that Ohio has a high likelihood of success, Judge Cole also noted that that the Treasury Department regulations could cure the ambiguity gives him some "pause," which leaves open the possibility he might ultimately rule in favor of the federal government.

Nonetheless, his ruling identifies the key flaw in the tax condition, one that will not be easy for the Biden Administration to overcome.

UPDATE: It's worth noting that there are now several other lawsuits filed against this provision by various states.