Historic Tax Cuts

States faced with budget surpluses and Republican-held legislatures are proposing aggressive tax cuts, which will most benefit the wealthy, arguing that they will stimulate a post-pandemic economy.

In addition to multiple billions of dollars’ worth of regressive tax cuts in Arizona, Ohio, and Wisconsin, a handful of other states are considering income tax cuts. Most states already have regressive tax codes, meaning low-income households pay a larger portion of their income in taxes than wealthy households, in part because states rely on property and sales taxes, both of which are regressive.

Income taxes tend to be one of the only progressive revenue sources that states have, so naturally there has been a movement in conservative states to lower or eliminate income taxes altogether.

In February, the Mississippi House of Representatives passed a bill to eliminate the state’s personal income tax, before it was killed in committee in the state senate. In March, West Virginia governor Jim Justice submitted a proposal to the legislature to eliminate the state’s income tax. Iowa governor Kim Reynolds said in June that she was considering a proposal to eliminate the state’s income tax, adding, “That’s where (other states are) going. And if you listen to governors, that’s kind of their goal in several states.”

A last-minute provision added to the ARP by Senate majority leader Chuck Schumer was intended to prevent states from using the influx of federal aid to subsidize these types of tax cuts. But the interim rule published by the Treasury Department to enforce this provision seems to have been written broadly enough that even billions of dollars of regressive tax cuts fall within the rules.

Will Treasury Stop Them?

The ARP’s ban on using aid to subsidize tax cuts was a welcome, last-minute surprise for progressives. Schumer’s inclusion of the provision suggested that the Democrats had learned a lesson from two mistakes that plagued the years following the Great Recession: inadequate federal aid to state and local governments, which employ about 16 million people, and Republican state legislatures aggressively cutting taxes in the hopes of sparking a recovery under the logic of trickle-down economics, but instead bankrupting their own public services.

But when the legislation passed, experts warned that the devil would be in the details of implementation. In particular, the fact that money is fungible makes it difficult to discern whether the aid is being used to fund a tax cut if a state passes tax cuts.

The Treasury’s solution was a rule preventing states from going below their revenue for the 2019 fiscal year — before the pandemic — with a little bit of wiggle room. If a state’s new tax cuts drive its revenues below those 2019 levels before it has spent federal pandemic aid, that state must return all of the aid to the federal government.

By accepting the ARP money, which every single state did, states consented to these strings attached to the rules.

States that cut taxes, under the rules, will have to prove to the Treasury that they didn’t go below 2019 revenue levels in any fiscal year in which they spent ARP money, depending on how aggressively the department enforces the rule. That means that any possible enforcement wouldn’t take place until at least the end of this fiscal year.

But Richard Auxier, a senior policy associate in the Urban-Brookings Tax Policy Center who studies state tax policy, said that the rules aren’t really targeted at states like Arizona, Ohio, and Wisconsin.

“They weren’t looking to go through the budget documents of states that are economically performing well. It was that they didn’t want a state that is in a real fiscal bind, that was in danger of cutting budgets and therefore cutting jobs, keeping those budget cuts instead of passing tax cuts.”

Instead, he said, the states that have been outspoken about the rule are the ones facing better-than-expected revenue projections, in addition to the federal aid.

“Of course, there are going to be states out there that are performing well that want to cut taxes, and then we are just going to go into all of this math and these rules,” Auxier said. “But what the rules are really trying to stop are states that are in the roughest condition, who the ARP is helping and keeping afloat, and preventing spending cuts.”

Ohio is one of those states that has responded to a good revenue year with a tax giveaway to the wealthy — and whose attorney general has led a battle among Republican states to fight the principle of the Treasury rule, even though the state will likely not violate it with billions of dollars of tax cuts.

“A Bit of a Nothingburger”

Republicans have been fighting the tax cut provision of the ARP since the moment it passed. Senator Mike Braun (R-IN) introduced the Let States Cut Taxes Act to repeal the provision.

“Not only did this blue state bailout bill penalize states for reopening by calculating state funds based on unemployment, now they are trying to use it as a back door to ban states from cutting taxes. My bill would make sure they don’t get away with it,” Braun said in a statement.

The ARP does not, as Braun said, ban states from cutting taxes — just from using ARP money to fund tax cuts.

Meanwhile, a coalition of Republican attorneys general sent a letter to Treasury secretary Janet Yellen asking her to clarify the provision.

“Absent a more sensible interpretation from your department, this provision would amount to an unprecedented and unconstitutional intrusion on the separate sovereignty of the States through federal usurpation of essentially one half of the State’s fiscal ledgers (i.e., the revenue half),” the letter said.

The rule that Yellen ultimately published did not prevent states from cutting taxes, but a number of states have still filed lawsuits protesting the rule. Recently, a federal judge in Ohio gave the state a victory in granting a permanent injunction against the implementation of the rule there.

The case, brought by Ohio attorney general Dave Yost and backed by the US Chamber of Commerce and the National Federation of Independent Business, argued that the federal government was unconstitutionally coercing Ohio into accepting its tax policies.

But there’s a long precedent of the federal government attaching conditions to money it sends to states. Moreover, says Darien Shanske, professor of law at UC Davis and expert in state taxation, Ohio had already accepted the terms.

“The Ohio case was poorly decided, because Ohio had already certified that it could live by the regulations by accepting the ARP money,” Shanske told us. “The judge ruled that Treasury cannot enforce this mandate, but Ohio has already told the Treasury that it can live by the mandate.”

The Treasury Department had similarly argued that Ohio lacked standing because it hadn’t yet passed any tax cuts that could jeopardize its federal aid.

Not only was the judge ruling on a moot point but a number of anti-tax groups had also come to the conclusion that the Treasury rules wouldn’t be a problem for a state like Ohio, Shanske pointed out. The law firm Eversheds Sutherland concluded about the rule: “When all is said and done, the ARPA clawback, following the interim rule, seems to be a bit of a nothingburger.”