Republican states are trying to use federal covid aid to cut taxes

More than a year after Congress approved a $1.9 trillion coronavirus relief package, Republicans in nearly two dozen states have ratcheted up efforts to tap some of those funds for an unrelated purpose: paying for tax cuts. The moves have threatened to siphon off aid that might otherwise help states fight the pandemic, shore up their local economies or prepare for a potential recession.

The intensifying Republican campaign targets one of the signature programs Democrats approved as part of President Biden’s American Rescue Plan last year. At the urging of the nation’s mayors and governors, Congress delivered what largely amounted to a blank check for every city and state to bolster their budgets.

Congress ultimately laid down few conditions for how local leaders could use the pot of money, which totaled $350 billion nationally. But they were clear about one thing: The federal government would not subsidize state tax cuts. Lawmakers led by Sen. Joe Manchin III (D-W.Va.) said at the time that Washington should not be on the hook to pay for reductions in state tax revenues, since that could leave major budget holes once federal aid ran dry.

Since then, however, GOP leaders have challenged the tax cut prohibition in federal courtrooms and state capitals. Attorneys general in 21 states have fought to overturn the Biden administration’s policy, federal court filings show, backed at times by powerful groups like the U.S. Chamber of Commerce, whose corporate members have lobbied conservative-leaning states to reduce their tax bills. In nearly every case, these legal efforts have prevailed, hamstringing the Treasury Department while opening the door for states to pursue their own tax cuts.

In Florida, the legal wrangling has enabled DeSantis and his political allies to leverage about $200 million in federal coronavirus aid to help pay for a planned suspension of the gas tax this October, according to state budget documents. Lawmakers essentially adopted a law that deposited its allotment under the stimulus program into the state’s general fund, then appropriated the money for the tax holiday, records show.

The policy, set to take effect later this year, could be in direct conflict with the federal tax restriction, local lawyers and advocates say. But Christina Pushaw, a spokeswoman for the governor, blasted the tax prohibition in a statement, calling it “not legally valid.”

The spending decisions have troubled some fiscal experts, who fear that the push for aggressive tax cuts this year could leave state budgets lacking much-needed revenue in the event of a recession. The moves also have flummoxed local advocates, who say that every federal dollar devoted to lowering tax bills is one less available for targeted relief — from improvements in housing to investments in aging infrastructure.

“You have to look at the opportunity cost of what else they could have done with American Rescue Plan dollars,” said Esteban Santis, a budget analyst at the Florida Policy Institute.

The controversy around the state and local aid program reflects a broader challenge facing Washington as it looks to keep watch over more than $5 trillion in emergency spending approved since the start of the pandemic. The loans, grants, direct checks and other assistance exceeded the size of the entire federal budget in fiscal 2019, creating a unique and lasting strain on policymakers to ensure the funds have been put to proper use.

The investments helped deliver public health resources, put vaccines in millions of Americans’ arms and pull the economy out of its worst crisis since the Great Depression. But the aid also has become a wellspring for fraud and abuse, reflecting the haste with which Washington crafted and enacted the historic spending packages.

Initially, federal lawmakers had hoped to stave off what they thought would be a fiscal doomsday. In the earliest days of the pandemic, they had heard an earful from the nation’s mayors and governors, who feared that rising public health costs and falling tax revenue would create shortfalls and force them to make cuts, including massive layoffs.

A similar crisis persisted long after the 2008 recession, cleaving massive holes in local governments’ finances that took years to reverse. So Congress enacted the $350 billion state and local fiscal recovery fund as part of Biden’s rescue plan, aiming to ease local budget deficits, finance new economic initiatives and even enable cities and states to make longer-term investments in infrastructure.

The state and local aid complemented a slew of stimulus programs that put billions in the pockets of Americans — in the form of stimulus checks, child tax payments, unemployment benefits and a flurry of other direct aid. All of the money soon produced a surge in consumer spending, and with it, a once-unexpected increase in tax revenue. Over the second, third and fourth quarters of the 2021 fiscal year, for example, major sources of state tax revenue surged by more than 20 percent compared with the same period in 2020, according to data compiled in May by the Urban-Brookings Tax Policy Center.

What initially seemed like an unfathomable economic crisis became an unexpected boomlet in city halls and state capitols, paving the way for policymakers — largely Republicans — to try to seize on the friendly fiscal climate to push for long-sought tax cuts.

The GOP crusade began about a week after Biden signed the American Rescue Plan last year. The Treasury Department had not even started writing its set of draft agency rules when Republicans mobilized to undo the prohibition on using the money to cut taxes. Led by Arizona, Georgia and West Virginia, attorneys general from 21 states last March threatened action over a policy they saw as an unconstitutional encroachment on states’ rights.

The Treasury Department soon clarified that nothing stopped states from using their own funds for tax cuts, provided they could afford them, no matter what they did with federal relief money. But the assurances didn’t mollify Republicans, who filed six major lawsuits challenging the policy over the next year.

In one seminal case, brought by Alabama and West Virginia with the support of 11 other states, Republican officials argued that Washington had no right to dictate how they spend their money, balance their budgets or set tax policy. They said the stimulus had forced them to make an “untenable choice” between relinquishing “control” of their taxing powers or surrendering “massive and much-needed aid.”

The argument that the states needed the money stood in stark contrast to the comments of their Republican representatives in Washington, who had voted unanimously against the package out of a belief that it was wasteful.

The Republican attorneys general pointed to a slew of pending tax proposals, including some targeted at low-income Americans, that they said their states might not be able to pursue if Washington enforced its mandate too aggressively. The Treasury Department countered that it had not stood in the way of those policies, but GOP officials sought to go further. In a flurry of court filings, many of the states argued for the ability to move money around freely — plugging federal dollars into various parts of their budgets, for example, then using the savings to pay for state tax cuts.

Republicans have won nearly every federal lawsuit, convincing judge after judge that the rules are unconstitutional. The Treasury Department repeatedly has appealed, but the decisions for now have left the Biden administration unable to enforce the rules in much of the country. That includes Florida, one of the 13 states to have prevailed earlier against the Treasury Department. A federal judge blocked the U.S. government from enforcing the tax prohibition in November, essentially preventing Washington from threatening to claw back funds. A court is set to hear an appeal later this year.

“Treasury has a robust compliance process for reviewing programs after a government has initiated them and begun reporting to the Department,” agency spokeswoman Liz Bourgeois said in a statement.

As the court cases play out, 24 states have slashed income, sales or major excise tax rates over the past two fiscal years, according to the Tax Foundation, primarily by cutting individual income rates in ways that provided relief to families as well as some businesses. None of the cuts appear to rely directly on federal pandemic aid, though some states paid for the rate reductions out of broader savings achieved thanks to federal coronavirus funds — or, at least, the economic improvements that Washington-led investments helped bring about.

“Much of the movement on tax reform and tax relief began before any court had ruled on the tax mandate,” said Jared Walczak, the vice president of state projects at the foundation. “However, the multiple court decisions favoring the states has created more comfort around tax relief.”

In Tennessee, for example, Gov. Bill Lee (R) signed into law a new version of his state’s budget this year that offered fresh sales tax relief, including a two-week pause on taxes that normally would apply to groceries and prepared food. (Tennessee has no individual income tax.) To pay for it, the state tapped $100 million from its general funds, according to budget documents. But the money was available partly because the state previously secured more than $700 million in “reversions,” a technical term for money transferred from key state agencies back to its general coffers. Some of the savings were made possible because those same agencies had received federal stimulus aid, the local officials said.

The maneuvering reflects a signature challenge facing the White House, where a top aide — speaking on the condition of anonymity to describe the administration’s internal thinking — acknowledged that stimulus funds are fungible. Similar troubles have plagued other coronavirus relief programs: In Texas, for example, state leaders shifted federal coronavirus dollars around in the budget to help free up funds for a crackdown on immigration, The Washington Post previously reported. The inspector general for the Treasury Department is now investigating the matter.

“States are always creative in how they come up with tax cuts and create workarounds,” said Lucy Dadayan, the leader of the State Tax and Economic Review project at the Tax Policy Center. She attributed the cuts to both “federal funds and the strong growth in revenues.”

But Dadayan predicted possible trouble on the horizon, particularly if the United States enters a recession that cuts deeply into economic activity nationally and once again depletes states’ tax receipts. “Once the states run out of the federal funds, then they are going to face challenges to fill the gap for lost revenues,” she said.

The loose strictures on the state and local money, as drawn up by Congress in the American Rescue Plan, have compounded the challenge of oversight. In June, the U.S. government finally released spending data for a fraction of the money through the end of December. Gene Sperling, a top White House aide overseeing the law’s implementation, said much of it had been spent as intended “to address issues like violence prevention, broadband, workforce development and affordable housing.”

Other states appear to be eyeing additional tax cuts in the event they succeed in a slew of lawsuits that could eventually reach the Supreme Court. In Montana, for example, a spokesman for Gov. Greg Gianforte (R) blasted the overall stimulus plan as “fiscally irresponsible” yet added in a statement, “The governor will consider next steps should Attorney General [Austin] Knudsen’s suit prevail.”

Adding to the pressure on the Treasury Department, the U.S. Chamber has participated in six of the lawsuits, each time arguing in favor of granting states flexibility to set tax policy. The group’s members would stand to gain from lower corporate taxes, including those financed by federal relief dollars.

“We benefit when states experiment in how to keep and attract more small businesses based on their tax policy,” said Tom Sullivan, the vice president for small-business policy at the Chamber. “We’re going to fight them every step of the way.”

In some states, the U.S. Chamber has scored additional tax victories: It has encouraged legislators and governors to use their federal dollars to shore up their unemployment insurance programs. Many states’ jobless benefits ran dry earlier in the crisis, forcing them to borrow from Washington to pay checks to a record number of out-of-work Americans. Normally, that might prompt states to raise taxes on businesses to replenish the funds — but the Chamber has instead encouraged states to fill the gaps using federal relief money.

By the end of last year, at least 16 states had committed about $14 billion toward replenishing their unemployment funds, according to federal data reviewed by The Post. The moves in some cases spared businesses from tax hikes, but they also cleaved deeply into money that these governments might have put toward other health or economic initiatives. Sullivan confirmed the Chamber and its members had lobbied for such a move in parts of the country, arguing that tax increases could have set back businesses fresh off an economic downturn.

Republicans in Washington also have joined the crusade. Last year, 78 Republicans in the House and Senate — represented by Jay Sekulow, a former top lawyer to President Donald Trump — intervened in the suit filed by Alabama and West Virginia to argue that Congress had exceeded its power. Some of those same lawmakers, including Sens. Mike Crapo (Idaho) and Rob Portman (Ohio), later asked a federal watchdog to review the Biden administration’s implementation of the rules.

The outcome of those lawsuits could carry significance far beyond the American Rescue Plan: It could affect not only the fate of the $350 billion aid program but the ability of Washington to police critical elements of future stimulus packages.

“States want the power to put in their own policies and be able to set fiscal policy the way they want,” said Jamie Yesnowitz, a top state tax lawyer at the firm Grant Thornton. “They don’t want to be stifled by this provision that essentially says, ‘Hey, the federal government is going to give you this money, but there are significant strings attached to it.’ ”