Were Future State Tax Cuts Just Cancelled by Uncle Sam?

The newly-minted American Rescue Plan Act includes $350 billion for State and Local Fiscal Recovery Funds. This is despite early reports that show total state and local revenue actually increased in calendar year 2020, and the fact that many states currently enjoy significant surpluses. This is also in addition to the hundreds of billions in federal assistance that was sent to state and local units of government through the CARES Act and other measures in 2020. ALEC has raised policy concerns around the idea of the federal government bailing out state and local budgets, regardless of which party was in control of Congress or the White House, due to profound threats to fiscal responsibility and federalism. Additionally, hundreds of ALEC state legislators voiced their numerous policy concerns. These efforts were recently recognized by ALEC Alumnus, Congressman Jim Banks:

As ALEC has correctly brought to public attention, the creation of new federal grants come with strings attached in the form of new regulations. State and local governments that would want to turn down these grants would then find themselves at a disadvantage. They would be left watching their taxpayer’s money forcibly sent to finance boondoggles in other states. The states that do take these funds would have their power limited under the weight of federal regulations.

Now that this bailout of state and local governments has been signed into law by President Biden, there is perhaps an even more troubling element than any of us could have anticipated. As the editorial board of The Wall Street Journal recently pointed out, states are prohibited from using these new federal funds to cut taxes through 2024.

From The Wall Street Journal:

The bill ex­plic­itly bars states from cut­ting taxes. States “shall not use the funds,” the bill says, “to ei­ther di­rectly or in­di­rectly [our em­pha­sis] off­set a re­duc­tion in the net tax rev­enue” that re­sults “from a change in law, reg­u­la­tion, or ad­min­is­tra­tive in­ter­pre­ta­tion dur­ing the cov­ered pe­riod 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.

With the fungible nature of budgeting, and absent any clarifications from the U.S. Department of Treasury, the incredibly ambiguous language involving indirect net revenue reductions could mean that any tax relief at the state level could potentially be called into question by aggressive federal action. This will undoubtedly harm state taxpayers and the future economic competitiveness of states.

To address this glaring policy mistake, U.S. Senator Mike Braun’s “Let States Cut Taxes Act” would allow states more flexibility in the way they can use federal funds, if they chose to take the money. Congressman Dan Bishop is working on ideas to address this issue as well.  Absent reforms like these, states will be pressured into using federal funds to grow government and baseline spending totals. America watched this play out more than a decade ago with the Obama-era “American Recovery and Reinvestment Act of 2009” (ARRA) and those infamous “shovel ready” projects. Growing state government bureaucracy with federal funds would create massive state budget challenges as the money disappears, but the costly federal requirements live on for years to come.

Moreover, the use of federal coercion to artificially elevate state tax burdens at a time when small businesses and hardworking American taxpayers need real tax relief is nonsensical. Through reports like Rich States, Poor States, ALEC has spent decades working with state policymakers and watching them unlock more prosperity for their citizens by adopting pro-growth tax and economic reforms. Having the federal government use “the power of the purse” in an attempt to curtail the use of competitive federalism is incredibly damaging to our American system of government.

The fundamental principle of federalism must be protected so that states can be allowed to continue their progress in pursuing economic gains as the “laboratories of democracy.” Restricting states from providing pro-growth net tax relief tips the balance of federalism significantly in the direction of the federal government, and its one-size-fits-all central planning.