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

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Biden Stimulus Bill Provision Targeting State Tax Cuts Might be Struck Down by Courts for Same Reasons as Trump Efforts to Pull Federal Grants From Sanctuary Cities

As co-blogger Josh Blackman notes, District Judge Douglas Cole yesterday made a ruling that the state of Ohio has “a significant chance” of success in its efforts to challenge a provision in the February 2021 stimulus bill that bans states from receiving federal grants also denied Ohio’s request for an injunction blocking enforcement of the condition (largely because the Treasury Department did nothing to enforce it and it is unlikely to happen anytime soon).

Meanwhile, just two days before the verdict, the Treasury Department issued a preliminary final rule interpreting the law, including the tax rule. As we shall see, this rule significantly limits the potential scope of the condition and appears to be designed to protect it from legal challenge. It’s a very sensible policy. However, the most significant legal weakness of Section 602 cannot be fixed: The fact that Congress has not made it nearly clear what exactly the rule means. The executive cannot rectify this error afterwards.

I. The constitutional problem with the tax condition

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

A State or Territory may not use the funds provided under this Section or transferred under Section 603 (c) (4) to directly or indirectly offset a decrease in the net tax revenue of that State or Territory due to a change in law. Regulation or administrative interpretation during the period covered [from now till December 31, 2024] This will reduce any tax (by providing a reduction in the tax rate, discount, deduction, credit, or otherwise) or delay the imposition of a tax or tax increase.

Ohio has filed a lawsuit alleging this provision is unconstitutional because it violates two long-standing restrictions on terms associated with federal grants to state governments. First, Congress could not “clearly” clarify the nature of the condition, as requested in Supreme Court cases such as Pennhurst v Halderman (1981) and South Dakota v Dole (1987). Second, the amount of money (around US $ 350 billion) is so high that the condition becomes “mandatory” and thus runs counter to the various precedents of the Supreme Court, in particular NFIB v. Sebelius (2012).

As I explained in my previous post on this case, the problem of ambiguity is the biggest problem for defenders of the law. The text leaves a number of important points unclear, including 1) how we calculate whether a tax cut will “reduce net tax revenue”, 2) whether it will apply to previously enacted tax cuts that only take effect during the period covered, and 3) whether a State, if it breaches the condition, can “offset” all of its ARPA grant money or just the portion that is offset by the “reduction in net tax revenue”.

Judge Cole addresses this issue in his decision:

Despite reflecting on this legal language, the Court cannot understand what it would mean to “indirectly offset a decrease in net tax revenue” of a state with a “change in the law … that lowers any tax (by providing for a reduction in a) rate , a discount, a deduction, a credit or otherwise) … “

[W]here things are hopelessly mixed up with regard to “indirect” and “net tax revenues of such a state”. Start with the latter sentence. Net tax revenue measured on the previous financial year? Or against what would have been collected without the change in taxes? Or what? And how do you “evaluate” the problem in both cases? In other words, let’s say a state decides to increase its statewide sales tax but lower its income tax. Or a state may choose to change how progressive its income tax rates are. Does this cause a reduction in “net tax revenue”? Eventually, the state can pass the package of tax changes (or even a single tax change) on the assumption that the state will raise more taxes as a result, but may simply be wrong.

That alone would be bad enough, but the ARPA then clumps “indirectly”
Offset “above. The court honestly has no idea what an” indirect offset “to net tax is
Income can be. At an oral hearing it became clear that it was a federal government
largely unwilling to venture a guess as to what it meant.

It is obvious that these are ambiguities. And they’re important, not just small details. As Judge Cole noted, the problem cannot be resolved by arguing, as the Biden administration has argued, that “the spending clause does not require that the terms of the conditions be clear, but that the law simply makes it clear that conditions exist”. This, as he correctly points out, contradicts the Supreme Court precedent.

II. Can the finance department fix the problem?

However, as Judge Cole notes, the government has one last ace up its sleeve: Perhaps the ambiguity can be resolved by the interim final rule the Treasury Department issued just two days before its decision. In contrast to the text of the law, this rule is admirably clear. Yale Law School Prof. David Schleicher, a leading academic expert on fiscal federalism, posted a helpful summary on Twitter:

[The Treasury Deparment rules] States must notify the federal government of tax cuts, but will not block the state tax cuts if a state’s total revenue is higher than 2019 (a baseline before coronavirus). OR tax cuts can be offset by (a) real spending cuts; (b) other tax changes or (c) economic growth …

It seems that a state could only be affected if it aggressively cut taxes below the 2019 fiscal year baseline without taking countermeasures or in response to real economic changes.

David is absolutely right to say that these rules are clear. I think he also puts forward a strong political rationale for them: They maintain a significant level of state autonomy while reducing the moral hazard that comes from federal subsidies.

I would add that the rules also indicate that “[a] The recipient government does not have to repay the Treasury an amount greater than the actual tax revenue of the recipient government shoard case relative to the baseline (i.e. tax revenue for the 2019 financial year, adjusted for inflation). “This significantly reduces the amount of money at stake for states and likely rules out any possibility of the condition being classified as ‘compulsive’ as this concept has been interpreted by the US Supreme Court in NFIB v. Sebelius.

If these rules were indeed included in the law, the Ohio lawsuit would likely be doomed. The problem is that the treasury rules, no matter how sensible they are, are not in the law. As Judge Cole puts it:

[I]It is not at all clear that the [Treasury] The secretary can even cure a spending clause ambiguity program through definitive rules. As mentioned above, this may be the case because the expenditure clause is an Article I. [legislative] Power, it is Congress, not the executive officials, who have to provide the necessary clarity.

In my opinion, there is no such thing as “maybe”. As the Supreme Court stated in the 1981 Pennhurst decision – the leading precedent in this area – “” (emphasis added). In addition, over the past four years, a slew of lower court rulings involving both Conservative and Liberal judges have invalidated various efforts by the Trump administration to put pressure on protected cities by exploiting vague legal language, to impose immigration enforcement conditions on various federal grants. The courts have repeatedly ruled that such conditions must be set by Congress, not the executive branch. Because of this, Trump lost almost all of these cases (with one significant aberrational exception). The Biden government’s interpretation of the tax condition has similar flaws.

Given the Treasury’s tight conditions, one might wonder what harm it would do to keep them up. Most states would hardly or not at all restrict their powers to cut taxes. And for reasons outlined by David Schleicher, the Treasury Department’s version of the condition makes political sense (assuming we need to have the ARPA grants at all, which I doubt).

The problem aside from purely legal considerations is that if the courts honored these executive-created conditions, they would open the door to other executive efforts to use vague laws to create their own conditions in order to state and local governments pressure to do so The White House commandment. The Trump administration’s gimmicks in the Protected Cities cases are a good example of what can happen. Furthermore, such widespread delegation of spending powers to the executive undermines the separation of powers and increases the already dangerous centralization of power in the White House. What I have written about the broader missions in the cases of the protective cities also applies here:

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

Since there are a variety of federal grants, this would give the executive a massive club to compel states and localities on a variety of issues. Conservatives may cheer when the current government uses this tool against protected cities, but are likely to regret their excitement when a Liberal Democratic president uses the same tactic to force states to pursue left-wing politics.

Taking advantage of vague legal language is a way for the executive branch to create its own conditions – one that is almost as dangerous as simply putting together conditions out of cloth. Given the multitude of federal grant laws, there are many ways to take advantage of the vagueness in this way.

The tax condition fall could make some conservatives belatedly happy that the Trump administration was beaten up in the Shelters cases. For the same reason, liberals should be careful about giving the next Republican government the power it would have if Biden succeeded in winning the tax mandate case.

Yesterday’s decision is far from a final solution to the case. It’s not even a final decision by the local court. Judge Cole, while emphasizing that Ohio has a high probability of success, also noted that Treasury Department regulations may remove the confusion that gives him a “pause” that leaves open the possibility that he might ultimately decide in favor of the federal government.

Nonetheless, his judgment identifies the main flaw in the tax condition that the Biden administration will not be able to easily overcome.

UPDATE: It’s worth noting that several other lawsuits have now been filed by various states against this provision.