Federal Judge Rules Against ARPA’s Tax Mandate

September 27, 2021

Kentucky and Tennessee won an important legal victory Friday when a federal court ruled that the American Rescue Plan Act (ARPA)’s restrictions on state fiscal autonomy were unconstitutional and enjoined (blocked) the enforcement of those provisions against both states. Specifically, Judge Gregory Van Tatenhove held that the ARPA provision, which limited states’ authority to cut taxes if they accepted their share of the $195.3 billion in state Fiscal Recovery Funds provided under the bill, was unduly coercive and therefore unconstitutional. Other cases are working their way through the system elsewhere.

The plaintiffs, the states of Kentucky and Tennessee, advanced four arguments for why the Tax Mandate is unconstitutional. Although the court only decided on a single ground—coercion—it is worth briefly rehearsing each in turn.

First, plaintiffs argue that the provision fails the ambiguity test under Pennhurst State Sch. v. Halderman (1984), which stipulates that if Congress imposes a condition on states’ receipt of federal funds, it must state those conditions unambiguously. Under ARPA, states are prohibited from “directly or indirectly offset[ting] a reduction in net tax revenue” using Fiscal Recovery Funds, with no explanation of what constitutes an indirect offset or how a net tax reduction would be calculated. While an Interim Final Rule provided clarity on some points, it created additional uncertainty of its own, and beyond that, it is doubtful whether an administrative rule can “cure” a statute that is unconstitutionally ambiguous in its own terms.

Second, plaintiffs allege that the condition is impermissibly coercive. Going back to the New Deal era—covering most of the time in which the federal government has provided substantial assistance to states—the courts have recognized that, while the federal government can undeniably put stipulations on the use of aid to states, any conditional offer cannot be unduly coercive, denying states their normal scope of autonomy under a system of dual sovereignty. Essentially, if acquiescing to federal conditions is necessary to receive funding, it must be realistically possible for the state to decline. Kentucky and Tennessee argue, convincingly, that the financial inducements offered under ARPA were too substantial to allow a truly free choice.

Third, the states assert that the tax cut limitation was not reasonably related to the purposes of ARPA, and that any interference with states’ autonomy must be held to at least that high a standard.

Fourth and finally, the states contend that the provision violates the anticommandeering doctrine, under which Congress is prohibited from commandeering a state’s legislative process by dictating its scope of action or instructing it on what it may or may not do. There are a number of cases on this point, most notably New York v. U.S. (1992). The states maintain that, functionally, ARPA dictates state fiscal policy, which is one of the fundamental prerogatives of state power.

In issuing a permanent injunction against the mandate, Judge Van Tatenhove focused exclusively on the coercion argument. The ruling acknowledges that the states “may very well be correct” about the other three grounds but refrained from anticipating additional questions of constitutional law when, in the court’s opinion, answering only one would suffice.

As Judge Van Tatenhove notes, the federal government can offer conditioned funds to states, but this power comes with limits. There is little doubt that the government can prohibit the direct use of ARPA funds to facilitate tax cuts if it so chooses, just as it can limit their use to an enumerated set of potential expenditures (which it does). But difficulties arise when Congress goes beyond conditioning the direct use of the funds to putting broad limits on “indirect” use which implicates a wide range of state fiscal choices. As the Supreme Court has previously ruled, Congress cannot enact legislation that uses financial inducements to exert a “power akin to undue influence,” and while “influencing a state’s policy choices” is permitted, Congress oversteps its authority under the Spending Clause when “pressure turns into compulsion.”

Conditioned aid to states creates a sort of contract, and the courts have held that states must have the freedom to “voluntarily and knowingly accept” the terms of that contract. “Relatively mild encouragement,” such as when the federal government conditioned 5 percent of a state’s highway funds on it raising the drinking age to 21, was held permissible, because rejecting the aid would not be unacceptably difficult, and thus the policy choice remained the prerogative of the state. By contrast, threatening states with the complete loss of all Medicaid funding if they declined to expand the program, as required by the language of the Affordable Care Act, was struck down, likened not to mild encouragement but “a gun to the head.” In the words of an appellate case favorably cited by Judge Van Tatenhove, these contracts of adhesion cross the line when they become “choice-bending” because they are almost impossible to refuse.

Citing the Tax Foundation, the court notes what is at stake for the states:

The States here know, as Kentucky and Tennessee show, that “refusing to accede to the conditions set out in the [law] is not a realistic option.” See NFIB, 567 U.S., at 681 (Scalia, J., dissenting). Whereas roughly ten percent of a State’s annual budget was at stake in NFIB, the ARPA offers States and the District of Columbia $195.3 billion dollars. See Jared Walczak, Four Questions Treasury Must Answer About the State Tax Cut Prohibition in the American Rescue Plan Act, Tax Found. (Mar. 18, 2021). For context, that is roughly twenty percent of the annual state tax collections brought in by state governments. Id. If both Kentucky and Tennessee choose to accept the ARPA funds—if it can be referred to as a choice—they will both receive amounts equal to roughly one-fifth of their general fund revenues for the preceding year. See How the COVID-19 Pandemic is Transforming State Budgets, Urb. Inst.; see also Jared Walczak, State Aid in American Rescue Plan Act is 116 Times States’ Revenue Losses, Tax Foundation (Mar. 3, 2021). [Citations simplified.]

The power to tax, as the court notes, is central to state governmental authority, a principle that has been affirmed by the Supreme Court going all the way back to Gibbons v. Ogden (1824). The judge concluded, rightly, that Congress’s restriction of this crucial aspect of our system of fiscal federalism exceeded the powers afforded the federal government by the U.S. Constitution.

Notably, in July, a federal judge in Ohio also permanently enjoined the enforcement of the tax mandate against that state, but did so on the grounds of ambiguity, treating this as the threshold question and thus not reaching a decision on the other grounds, including coercion. There, the judge wrote that “the Tax Mandate, as written, falls short of the clarity that Supreme Court precedent requires for Spending Clause legislation that provides conditional grants to States.” The federal court also “reject[ed] the Secretary’s argument that the Treasury Department regulations cure that ambiguity,” noting that, at a minimum, Congress must directly authorize an agency to supply the requisite clarity, and that an agency attempting to do this on its own cannot cure the defects of the underlying legislation.

That the provision is simultaneously coercive and ambiguous seems evident and are the most likely grounds for rulings against the Tax Mandate. It may well constitute commandeering, but it is difficult to imagine how a court could decide this without also reaching the narrower conclusion that it is unduly coercive, so this legal proposition may not be tested. And while some scholars firmly believe that the provision should also fail as not being reasonably related to the purpose of ARPA, which must be balanced against the stringency of the condition on states—and this may well be correct—it is also the case that courts have often given the government a long leash on what is “reasonably related” to legislative purposes.

The Kentucky and Tennessee case, like the Ohio one before it, only affects the states named as plaintiffs. In his opinion, the judge notes that the coercive elements are universally present, but he nonetheless restricts the scope of the injunction to the plaintiff states, declining to issue a nationwide injunction. In a few notable cases in recent years, district courts have controversially applied their decisions nationwide, whereas the judges in these cases have chosen a more modest approach. Twenty states, however, are represented across six pending lawsuits over several circuits, so future rulings may cover many additional states, and ultimately a national answer is likely to be provided by the appellate courts or—in the event that there is a circuit split, in particular—ultimately by the U.S. Supreme Court.

Two other district courts have upheld the provision for now, one by denying that states have standing (an argument Judge Van Tatenhove ably dispensed with, and which is unlikely to prevail on appeal), and another judge found the mandate legal. The process is far from over, but Friday’s ruling is a major development.

Was this page helpful to you?

No

Thank You!

The Tax Foundation works hard to provide insightful tax policy analysis. Our work depends on support from members of the public like you. Would you consider contributing to our work?

Contribute to the Tax Foundation

Related Articles