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POLICY INSIGHT
BEYOND THE NUMBERS

Rescue Plan Protects Against Using Federal Dollars to Cut State Taxes

The American Rescue Plan Act includes an important and novel provision: for every dollar that a state government spends on net tax cuts, it will lose a dollar of the federal fiscal aid it receives from the Act’s Coronavirus State Fiscal Recovery Fund. That’s sound policy.

Recessions are a terrible time for state tax cuts. Typically, the benefits of a tax cut go to people and to corporations that don’t need them. That’s the wrong approach when many working families continue to face serious economic hardship. Worse, every dollar in state tax cuts is a dollar not available for public services, which are in greater need and higher demand during a downturn.

Cutting state taxes now would repeat a mistake many states made in the wake of the Great Recession: they cut taxes, which harmed families, undermined economic growth, and exacerbated economic inequality and racial injustice. Instead, states should address critical health and economic needs by making investments that can help build antiracist, equitable states. To help them do so, the American Rescue Plan Act includes $195 billion in fiscal aid for state governments (and more for schools and for local, tribal, and territorial governments).

Before the bill passed, some states were considering damaging tax cuts — in part because they assumed the coming federal aid would help keep their budgets in balance. So Congress put a common-sense provision in the bill saying that if they do so, they’ll have to repay the federal government dollar for dollar. That provision is additionally helpful since states were considering using the one-time federal aid for permanent tax cuts, setting themselves up for budget cuts in the future when the aid expires and state revenues remain depleted by tax cuts.

Not surprisingly, some tax cut proponents are unhappy with this provision and are exaggerating its impact. Contrary to their erroneous claims, the American Rescue Plan Act does not stop states from cutting taxes. It says they can’t use federal dollars to do that, either directly or indirectly. If a state chooses to enact a net tax cut, it will forgo the equivalent amount of federal aid provided through the Act’s Coronavirus State Fiscal Recovery Fund. According to the Act:

(A) In general.—A State or territory shall not use the funds provided under this section or transferred pursuant to section 603(c)(4) to either directly or indirectly offset a reduction in the net tax revenue of such State or territory resulting 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.

Again, states will receive $195 billion in direct fiscal aid, plus billions more in fiscal relief for schools, counties, and cities. If state lawmakers want to cut taxes, regardless of the impact on state services, they can do so and still come out way ahead.

What’s more, only net tax cuts run afoul of the rule. So, a state could cut taxes for low-income families and raise them for wealthy ones, producing no net tax revenue reduction and no loss of federal aid. Tax changes like this would also advance equity and help reduce barriers faced by low-income families.

Further, the limitation on cutting state taxes is not permanent; it covers tax changes enacted after March 3 of this year and expires when the state has spent the federal aid, which is available to cover costs incurred through the end of 2024. As the Act explains:

The term 'covered period' means, with respect to a State, territory, or Tribal government, the period that —
"(A) begins on March 3, 2021; and

“(B) ends on the last day of the fiscal year of such State, territory, or Tribal government in which all funds received by the State, territory, or Tribal government from a payment made under this section or a transfer made under section 603(c)(4) have been expended or returned to, or recovered by, the Secretary.

And further:

a State, territory, or Tribal government shall only use the funds provided under a payment made under this section, or transferred pursuant to section 603(c)(4), to cover costs incurred by the State, territory, or Tribal government, by December 31, 2024.

And finally, the American Rescue Plan Act also doesn’t stop states from helping low-income families. On the contrary, states are encouraged to use the federal aid to help those families, which have borne a disproportionate share of the pandemic’s hardship. States may, for example, send a flexible cash payment to these families or help them pay rent or put food on the table.

In coming weeks, the Treasury Department will issue guidance on how this important provision will operate — in part, to make sure states and localities can’t find loopholes in it. In the meantime, this provision will help ensure that states take advantage of the historic opportunity the American Rescue Plan Act makes possible — a response to the pandemic and recession that fully supports people and businesses struggling now, and sets the country up for a stronger future, rather than even more austerity and inequality.