Washington baits a financial trap for states

In its first two months, the Biden administration and the 117th Congress have launched a breathtaking assault on state autonomy and the Tenth Amendment.

The PRO Act would usurp the most significant state labor laws. The For the People Act, H.R. 1, would do the same for state election laws. And with the recently signed American Rescue Plan Act (ARPA), the federal government has baited a financial trap for state governments. Billions of dollars are available for their spending … if they surrender to Washington their prerogatives to reduce taxes and to manage their unfunded liabilities.

The state and local relief funds section of ARPA allocates $220 billion to state governments and another $130 billion directly to local governments. The law explicitly allows states to do four things with these dollars: ‘‘respond to the public health emergency … or its negative economic impacts, including assistance to households, small businesses and nonprofits, or aid to impacted industries such as tourism, travel and hospitality”; give premium pay to essential state workers and grants to employers of essential workers; offset state revenue losses; and spend on water, sewer or broadband infrastructure.

The law also explicitly forbids states to do two things with this money. One is plain: States cannot deposit the money into any pension fund.

Public employee pensions and other post-employment benefits are the main fiscal threat to state governments. The combined unfunded liability of the 50 states at the end of 2018 was $1.24 trillion on the pension side alone. The 48 states that maintain defined benefit retirement plans owe another $1 trillion on their other post-employment benefits, mostly in health insurance. These liabilities exceed 5 percent of the gross state product in 18 states.

The hypocrisy of this prohibition is astounding, as a preceding section of ARPA explicitly bails out roughly 185 multi-employer pension plans to the tune of $86 billion.

Under the second prohibition, states cannot use ARPA funds to “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 intent of this language is to prevent any state that accepts these funds from making any tax cuts for the next four years. States must regularly report to the U.S. Treasury how they use ARPA dollars, as well as “all modifications to the State’s or territory’s tax revenue sources during the covered period.” ARPA also authorizes clawbacks of “the amount of the applicable reduction to net tax revenue attributable to such violation.”

Depending how the Treasury Department writes the rules, states that receive these federal dollars would be blocked from proposed tax law changes wholly unrelated to COVID-19 (e.g., exempting tampons for sales tax, or creating or extending tax credits). The rules could also interfere with a state’s ability to implement a previously adopted change in its own laws (e.g., automatic tax reduction triggers).

So how should states approach this latest offer of federal largesse? 

First, they should exercise due diligence and not be in a hurry to accept the money. Twenty-two states, including Michigan, had increased tax revenues during the last nine months of 2020. This is, in large part, because of the massive financial support to individuals and businesses from measures in past year’s two federal stimulus programs, including stimulus checks, Pandemic Unemployment Assistance and the Paycheck Protection Program.

States have until the end of 2024 to use ARPA funds. They have plenty of time, then, to monitor the Treasury Department’s rulemaking process and the Ohio lawsuit filed over the no-tax-cut provision before deciding how to allocate these funds — if they decide to accept them at all.

Second, and relatedly, states should not allow federal funds to undermine previous policy decisions. Federal stimulus packages frequently include conditions that Congress uses to buy its preferred actions in areas where it lacks direct authority. For example, ObamaCare included both carrots and sticks for states to expand Medicaid, with the sticks found to be unconstitutional on anti-commandeering grounds in NFIB v. Sebelius.

Third, states should not create ongoing obligations from one-time funds. States should make sure they are not left with new programs to fund once Uncle Sam’s credit card gets cut up.

Finally, states should work to improve their financial footing for the future. Many states have decaying transportation and water infrastructure, incomplete broadband deployment, and massive liabilities in their public employee pensions and other post-employment benefits. Given this, two of the best uses for ARPA funds would be to accelerate infrastructure projects and to develop funding workarounds that free up state general fund dollars for buying down pension and other liabilities.

David Guenthner is the senior strategist for state affairs at the Mackinac Center for Public Policy, a research and educational institute located in Midland, Mich.