This Last-Minute Provision Blocks GOP Govs from Using Stimulus Money to Subsidize Tax Cuts

Chuck Schumer Joe Biden Stimulus Bill
GOP governors are considering tax cuts for corporations or the rich, but a last-minute provision will keep them from using federal funds. Senate Majority Leader Sen. Chuck Schumer (D-NY) listens as U.S. President Joe Biden speaks during an event on the American Rescue Plan in the Rose Garden of the White House on March 12, 2021 in Washington, DC. Alex Wong/Getty Images

The American Rescue Plan's $1.9 trillion of spending represents a significant break with the budget-cutting, deficit-obsessed austerity ideology that has held sway since the Reagan Era. But that's not all it does. A provision tucked into the final bill also aims to halt the anti-tax movement that has drained state and local coffers of resources to fund infrastructure, public education, and other basic social services.

The language, slipped into the legislation at the last minute by Senate Majority Leader Chuck Schumer, is designed to prevent federal money from subsidizing new tax cuts at a moment when some Republican-led states have been considering them.

"Money from COVID relief needs to go to helping every day Americans get through the pandemic, not paying for tax cuts for the rich," Schumer said in a statement to The Daily Poster. "The American Rescue Plan explicitly prohibits states from using emergency COVID relief dollars to fund frivolous tax cuts. Governors should use this money to maintain public health and social assistance programs to fight the pandemic, and keep millions of other essential employees on the job and working for our communities."

The provision, coupled with Biden's upcoming plan to raise taxes on the wealthy, represents the first significant effort to explicitly combat the anti-tax movement that has dominated American politics for the last half-century.

Such efforts suggest Democrats have learned a valuable lesson since their 2009 economic stimulus bill about prioritizing public aid for local and state governments—and keeping that aid from being waylaid by Republicans' anti-tax zealotry.

The ban on using the federal aid to fund tax cuts in the states has already provoked outcry from Republicans, who are now trying to repeal the provision, and has been depicted as a Democratic attack on red states. But the provision isn't simply partisan tit for tat—it's about ensuring the ARP does what it is supposed to do, since data has shown that tax cuts are the exact opposite of what is needed to stimulate the economy.

"This isn't mere politics," Richard Auxier, senior policy associate at the Tax Policy Center, told The Daily Poster. "The federal government doesn't want to send a state billions of dollars, just to have them turn around and use it to pass a regressive tax cut that they've probably been debating for years before the pandemic."

West Virginia and Mississippi already had legislation in the works to end their state income taxes altogether, while Iowa is considering a phase-out of its inheritance tax. Florida lawmakers, meanwhile, were hoping to use the federal stimulus to subsidize corporate tax cuts.

Now, those tax cuts may be less appealing. If these states go forward with the tax cuts, they will either have to return to the federal government the amount of aid equivalent to the revenue loss created by the tax cuts, or agree not to receive it in the first place.

"Basically any tax cut done at the state level has doubled in cost," said Carl Davis, research director at the Institute on Taxation and Economic Policy. For example, if a state enacts a $50 million tax cut, it will lose $50 million in the revenue it won't collect and another $50 million in federal aid.

Under the ARP, these tax cuts will either have to wait until 2024 or be offset by other revenue-raising measures, or they will cost the state double what they would have originally cost.

The tax provisions suggest Democrats have absorbed the lesson of the 2009 American Recovery and Reinvestment Act, which passed in response to the Great Recession. That legislation offered far less in the way of federal aid to state and local governments sapped by revenue losses. And according to a Congressional Budget Office report, the tax cut provisions included in the measure provided a far smaller economic stimulus than direct spending.

What's more, as Republicans subsequently took over numerous legislative chambers, many states slashed revenues for public education and infrastructure, with at least eighteen states cutting income and corporate taxes and fueling disinvestment in public education and infrastructure.

Kansas demonstrated this phenomenon in 2012 and 2013, when Republican Gov. Sam Brownback and the state legislature cut income taxes on the wealthy by about 30 percent as well as cut taxes on businesses to nearly zero. In the years that followed, Kansas experienced some of the slowest private sector job growth in the region. The revenue loss led to a budget crisis, and Kansas' bond rating was downgraded while the legislature cut funding for education and infrastructure. The tax cuts were so unpopular that the Republican state legislature reversed them in 2017, against the governor's wishes.

A lack of state and local spending, exacerbated by these revenue-draining tax cuts, were likely one of the reasons the country's economic recovery after the Great Recession was significantly delayed. The prolonged slump disproportionately impacted women and African-Americans, since they are more likely than others to be employed in the public sector rather than the average worker.

Fast forward a dozen years and the ARP will send $350 billion to state and local governments to respond to COVID-19 and the economic crisis. Between this money and $150 billion in state and local aid included in the CARES Act last March, the federal government has funneled over $500 billion over the past year into shoring up the public sector. That is considerably more than the $318 billion that the 2009 stimulus bill provided to state and local governments that were for the most part worse off than they are now.

The current aid is desperately needed. While state and local revenues have not been hit as hard as they were during the Great Recession or other economic crises, over the past year, nearly 7 percent of state and local government employees lost their jobs, nearly three times the losses during the Great Recession.

The injection of funds from the ARP into state and local governments allows for investments in the systems whose vulnerabilities have been laid bare by the pandemic, such as public education, state unemployment systems, and health care. These investments have a high economic multiplier, meaning each dollar spent on things like schools, parks and recreation, and public health creates more than a dollar's worth of resulting economic growth.

But the full benefits of the aid could be largely cancelled out if politicians used the funds to justify slashing taxes, cutting off revenues these governments need for their full recovery.

"It very much would not boost the economic recovery if states then send that money to high-income people who have done well during this pandemic," said Auxier, the Tax Policy Center expert.

Schumer's tax cut ban was backed by a group of senators including Sen. Joe Manchin from West Virginia, where a political clash over the measure is already playing out. Republican Gov. Jim Justice submitted legislation earlier this month to repeal the state's income tax, and he has now accused Manchin of including the provision in the ARP to prevent his income tax repeal from passing.

In a sense, Schumer's measure flips the script on Republicans, who in 2017 included language in their major tax cut legislation that was designed to prevent federal resources from effectively subsidizing higher state and local property taxes often found in Democratic states. Only a few years later, the Democratic language in the ARP prevents those same federal resources from subsidizing the kinds of tax cuts that are popular in GOP-run states.

While those who backed the amendment might have been responding to state legislative proposals to cut taxes that were already in the works, they also could help usher in a reversal of the country's decade-long embrace of cutting local taxes.

For example, as a best-case-scenario, the ARP's provisions could encourage states to make the influx of revenue they receive from the legislation permanent through new progressive taxes. At least nine states are already considering revenue proposals such as higher income taxes on wealthy people, taxes on unearned investment income, and a tax on Wall Street trades, to name a few.

"In states where lawmakers want to invest in new programs, or further investment in education, for example, this funding will allow them to do that now without changing their tax policies," said David Cooper, senior economic analyst at the Economic Policy Institute.

Popular investments in health care or education programs could make passing new progressive taxes more politically feasible if constituents want to see such programs continue. "If they want to do something bold and lasting, they will need to create new dedicated revenue streams," Cooper said.

Actually enforcing the ARP's tax ban on funding tax cuts with federal dollars is another matter. The law says that states and localities can not use the aid 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."

The law is broadly written, covering both direct or indirect uses of the funds to offset tax cuts, and defines taxes to include "laws, regulations, or administrative interpretations."

Tax policy experts say that it's difficult to know how exactly the language will constrain states until the Treasury Department releases guidance on how the provision will be enforced.

While officials are already pressuring the department to issue such a directive, no one knows when that information will be released.

In the meantime, many questions remain. For starters, there is the matter of what counts as a tax cut.

"Maryland just passed an increase in its Earned Income Tax Credit, something I think we can all agree that is very much in line with the thrust of the American Rescue Plan. But that's a tax cut," said Auxier. "So with this provision, putting the timing aside, would this provision have prevented them from doing it?"

Other experts have raised the issue of corporate tax giveaways. Treasury Secretary Janet Yellen could interpret corporate tax subsidies, used by states and localities to lure businesses, as tax cuts, according to John Mozena of the Center for Economic Accountability.

There is also the issue of "conformity." Some states have a measure written into their tax codes which automatically transfers certain federal tax laws into state policy, unless the state passes a law barring the adoption of the federal policy. For example, the ARP exempts the first $10,200 of unemployment insurance that people received during the pandemic from taxation. States with rolling conformity will also exempt that money from income taxes. Is that a tax cut that will need to be offset with federal dollars?

Finally, there is the tricky question of state budget scoring. States and municipalities have to pay back any net revenue losses created by tax policy changes to the federal government. The challenge of enforcing this is that states differ widely in the economic assumptions they use to make their revenue projections.

Specifically, some states have begun to use the practice of "dynamic scoring" to assess the impacts of legislation, meaning that revenue estimates take into account how the policy will affect the economy more broadly, and capture those economic impacts in their projections. In 2015, when Republicans in Congress adopted dynamic scoring at the federal level, the right-wing American Legislative Exchange Council proposed that states also adopt the practice, pointing out that it could have been beneficial in North Carolina, where they said tax cuts led to increased economic activity. According to the report, such revenues showed "how pro-growth policies like lowering and simplifying taxes can lead to additional revenue."

"There's huge variation in the states on how thorough they are on scoring revenue legislation," said Davis, the ITEP expert. "For a tax provision, you might not have a revenue score at all. And since this language covers even regulations, that's even less likely to have a revenue score."

While some states may fail to make revenue projections about legislation, these projections are also often shaped by political assumptions, specifically about whether tax cuts will "trickle down" and stimulate the economy. For example, when Kansas enacted its sweeping tax cuts in 2012, the Republican-controlled state overestimated the amount of revenue that would be created from economic growth due to the tax cuts.

"I would be concerned that these state revenue scores, depending on who is doing them, could be subject to some political influence," said Davis. "There's a lot of wishful thinking about the economic effects of income tax cuts, and how much additional revenue can be raised through the trickle-down means."

Making sense of state tax policy could be a tall order for the Treasury. "They're going to have to follow state tax debates much more closely for these next couple of years than they traditionally do," Davis said.

Until the Treasury Department releases its enforcement guidance, tax policy experts say it's hard to predict how the federal government will come down on what counts as a tax and how to measure the revenue impact of different policies.

Depending on what Treasury officials decide, there is a chance that Republicans-led states could refuse to take the ARP's federal aid because of the constraints on tax cuts, just like they have done in the past with refusing to allow Medicaid expansion. The Heritage Foundation is now telling Republican governors to "reject these federal bailouts, because they will make cutting taxes harder and make growing the size and scope of government easier."