States question whether new federal stimulus law rules out tax cuts

Bill says state and local governments can’t use federal money to offset tax revenue reductions

(Getty Images)

WASHINGTON — President Joe Biden’s massive pandemic stimulus law pumps a welcome infusion of federal aid into state and local government coffers — but one brief section is raising questions about whether states are barred from cutting their own taxes if they accept the federal help.

The Senate added language to the COVID-19 relief package prohibiting states and local governments from using the $350 billion in direct federal assistance “to either directly or indirectly offset a reduction in the net tax revenue” or delay the imposition of any tax or tax increase.

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That provision doesn’t entirely prevent state officials from cutting taxes. Some scenarios, such as slashing one tax but offsetting it with a tax increase, wouldn’t be a problem. 

But until the Treasury Department offers more detailed guidance on how it will interpret the new law, the provision is causing uncertainty, particularly in places like Iowa, where tax cuts already are in the works.

Some Republicans in Washington and state capitals have criticized the provision as an unprecedented string attached to the federal dollars. The conservative Heritage Foundation has gone so far as to call on states to reject the federal assistance, even though bipartisan leaders of the National Governors Association have said direct aid is “essential” for states.

“Democrats in Washington and in the White House are not going to tell me, or the Georgia General Assembly, that we can’t cut taxes for hard-working Georgians,” Georgia Gov. Brian Kemp, a Republican, said at a press conference Wednesday, according to the Georgia Recorder.

Sen. Pat Toomey, (R-Pa.), who opposed the overall bill and sending more direct aid to state and local governments, said in a Fox Business interview, that the provision is a “dramatic expansion in the size of state and local governments that the federal government will control.”

Potential trouble spot

Tax policy experts describe a range of complex scenarios that could stymie budget officials and cause them to be in jeopardy of having to pay back the federal dollars.

In Colorado, those scenarios could involve bills in the state Legislature. During his State of the State address in February, Gov. Jared Polis proposed that Colorado double the earned income tax credit and provide up to $600 in child tax credits for nearly 200,000 families through the Colorado child tax credit. He also proposed elimination of the business personal property tax for small businesses. It’s unclear without Treasury Department guidance if such provisions would imply reductions in net tax revenue as defined by the federal stimulus law.

Proposed Initiative 14 in Colorado also could be implicated in the federal law. The ballot measure proposes to reduce property tax assessment rates in the state, and the nonpartisan Legislative Council Staff has estimated the measure will mean the state must backfill lost property tax revenue collected by school districts by about $280 million annually. It’s possible federal authorities could interpret such backfill as being accomplished with stimulus money, said Carol Hedges, executive director of the Colorado Fiscal Institute. Only further federal guidance will provide answers, she said.

Jared Walczak of the Tax Foundation, a D.C.-based conservative-leaning nonprofit focused on tax policy, said one potential trouble spot is if states use the money to pay the salaries of employees already on the government payroll, such as public health workers.