April 18, 2021 - Douglas Myser

Federal aid will hurt tax cuts. A condition attached to $350 billion in relief for state and local governments by the American Rescue Plan, P.L. 117-2---that states may not use the money to offset their own tax reductions---may prove problematic, and is perhaps unconstitutional, tax practitioners say. The Coronavirus State Fiscal Recovery Fund appropriates $220 billion in fiscal year 2021 for states, U.S. territories, and Tribal governments to mitigate the fiscal effects of the COVID-19 pandemic, available through the end of 2024. Another $130 billion is earmarked for similar payments to cities, counties, and other local governments. The funds may be used for a broad range of state and local governmental costs and aid, assisting households, small businesses, and not for profit organizations. The money may be used for grants and premium pay to essential workers, infrastructure investments, and aid to pandemic affected industries such as tourism, travel and hospitality. Federal aid will hurt tax cuts.

The funds may not be deposited into any pension fund. But an even broader, tax regulated restriction has some state and local government leaders concerned. The money may not "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). Implementing the provision leaves much to interpretation, but conflicts between states own incentives and drawing upon the funds may be brewing, observers said. "The timing of this provision will make it difficult for several states to figure out whether their current tax cut and relief proposals will cross the finish line this spring. If they want to be eligible for the funding, because some of these proposals could be construed as indirect offsets to revenue---even if planned prior to the Stimulus. That puts many state in a dilemma about what to do with policies developed prior to the enactment of the stimulus bill. Federal aid will hurt tax cuts.

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