Prohibition on ARPA ‘tax cuts’ declared unconstitutional

Fungible money debate also playing out with millionaire tax in Mass.

TWO RECENT COURT decisions indicate even the US government has limited influence over how states spend their money. 

The traditional way the federal government gains leverage over state policies is by using carrots – offering additional federal money, for example, if a state adopts a certain type of program or passes a specific kind of law. 

But when Congress in 2021 passed the American Rescue Plan Act, or ARPA, it tried to sway state fiscal practices using more of a stick approach. 

The goal of the law, a $1.9 trillion stimulus package to deal with the economic and health impacts of COVID-19, was to pump money into the stagnant economy, not to finance tax cuts. So states were prohibited from using any ARPA money they received “to either directly or indirectly offset a reduction in their net tax revenue.” 

What that meant is a state could not lower a tax or delay a tax increase and use ARPA funds to plug the gap. States that violated the so-called tax mandate could be forced to return their ARPA money. 

Every state signed on to accept the money, but 13 filed suit claiming the tax mandate was unconstitutional. The 13 states were Alabama, Alaska, Arkansas, Florida, Iowa, Kansas, Montana, New Hampshire, Oklahoma, South Carolina, South Dakota, Utah, and West Virginia.

A federal court sided with the 13 states and an appeals court last week unanimously upheld the decision. The appeals court decision went on for 42 pages, but its analysis of enforcement of the tax mandate provision was the most interesting.

A direct violation would occur under the law if ARPA funds were deposited in a state’s general fund in order to fill a revenue hole created by a tax cut. An indirect violation could occur if expenditures were reduced by $2 billion in one area of state government to pay for a tax cut of the same amount and $2 billion in ARPA funds was used to plug the hole.

“Extrapolating from the second example, an indirect offset could be boundless,” the appeals court ruling said. “Even a novice in accounting readily grasps that balancing a budget requires offsetting revenue shortfalls with other funds––or with expenditure cuts. Thus, because money is fungible, the secretary could always assert a plausible argument that a state, after a tax cut, committed an unlawful indirect offset of the attendant revenue shortfall.”

The situation sounds a lot like the predicament taxpayers may find themselves here in Massachusetts with the millionaire tax.

Voters in November approved a constitutional amendment assessing an income tax surcharge of 4 percent on income over $1 million, with the money collected going to support education and transportation.

Collection of the tax itself should be fairly straightforward, but requiring the money to be spent on education and transportation may be difficult to enforce given that any increase in funding from the millionaire tax could be offset by shifting funds in those areas to other parts of state government.

Evan Horowitz, executive director of the Center for State Policy Analysis at Tufts University, said federal regulators gave up fairly quickly on the idea of enforcing the so-called tax mandate in the ARPA law, largely because of the difficulty in tracing fungible money.

Horowitz sees that same concept playing out frequently at the local level, both with the millionaire tax and even with debate over scaling back the state’s estate tax. He said there’s no causal link between the new millionaire tax and efforts to reduce the estate tax, but many policymakers are connecting the dots between the two taxes because they both impact wealthy people and raising taxes with one and reducing them with another balances the scale in some sense. 

Meet the Author

Bruce Mohl

Editor, CommonWealth

About Bruce Mohl

Bruce Mohl is the editor of CommonWealth magazine. Bruce came to CommonWealth from the Boston Globe, where he spent nearly 30 years in a wide variety of positions covering business and politics. He covered the Massachusetts State House and served as the Globe’s State House bureau chief in the late 1980s. He also reported for the Globe’s Spotlight Team, winning a Loeb award in 1992 for coverage of conflicts of interest in the state’s pension system. He served as the Globe’s political editor in 1994 and went on to cover consumer issues for the newspaper. At CommonWealth, Bruce helped launch the magazine’s website and has written about a wide range of issues with a special focus on politics, tax policy, energy, and gambling. Bruce is a graduate of Ohio Wesleyan University and the Fletcher School of Law and Diplomacy at Tufts University. He lives in Dorchester.

About Bruce Mohl

Bruce Mohl is the editor of CommonWealth magazine. Bruce came to CommonWealth from the Boston Globe, where he spent nearly 30 years in a wide variety of positions covering business and politics. He covered the Massachusetts State House and served as the Globe’s State House bureau chief in the late 1980s. He also reported for the Globe’s Spotlight Team, winning a Loeb award in 1992 for coverage of conflicts of interest in the state’s pension system. He served as the Globe’s political editor in 1994 and went on to cover consumer issues for the newspaper. At CommonWealth, Bruce helped launch the magazine’s website and has written about a wide range of issues with a special focus on politics, tax policy, energy, and gambling. Bruce is a graduate of Ohio Wesleyan University and the Fletcher School of Law and Diplomacy at Tufts University. He lives in Dorchester.

“It’s now OK to reduce the estate tax because we have the millionaire tax,” he said. “The fact that the link can’t be pinned down is at the center of all of these discussions.”