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Treasury Department can’t enforce American Rescue Plan tax cut rule, 11th Circuit says

The Atlanta-based appeals court upheld an Alabama federal judge’s decision blocking the federal government from telling states they could not use pandemic relief funds to offset tax cuts.

ATLANTA (CN) — A provision of the American Rescue Plan Act which would have prevented states from using pandemic relief funds to offset new tax cuts cannot be enforced, a unanimous panel of the 11th Circuit ruled on Friday.

The Atlanta-based appeals court found that the rule barring states from using relief funds to offset a decease in their net tax revenue through the end of 2024 violates the spending clause of the U.S. Constitution. The language of the provision is too ambiguous and leaves state governments unable to ascertain the conditions imposed on their acceptance of the money, the 42-page ruling explains.

“The Rescue Plan’s offset provision has affected the states’ sovereign authority to tax by binding them to a deal with ambiguous terms and placing them on the hook for billions of dollars in potential recoupment actions,” U.S. Circuit Judge Andrew Brasher wrote on behalf of the panel.

The decision applies only to the tax offset provision and does not apply to other portions of the plan.

Passed by Congress in 2021 to help hasten the nation’s recovery from the economic impact of the Covid-19 pandemic, the American Rescue Plan distributed $195.3 billion in flexible relief funds to the states. The money was earmarked to support essential workers, invest in infrastructure and respond to the public health emergency caused by the pandemic.

Accepting a cut of the stimulus package required states to comply with certain conditions. One of those conditions is a rule asking states to agree that they will not use relief funds to directly or indirectly offset a reduction in net tax revenue resulting from state laws that reduce tax burdens.

But state officials have argued that the law is unclear on what it means to “directly or indirectly” offset tax cuts with relief funds.

The mandate prompted six federal lawsuits, including one filed in federal court by Alabama, Arkansas, Alaska, Florida, Iowa, Kansas, Montana, New Hampshire, Oklahoma, South Carolina, South Dakota, Utah and West Virginia. The states alleged that the tax cut rule could be read to prohibit states from passing tax relief of any kind because it did not make clear how reductions in net tax revenue would be measured to determine compliance.

An Alabama federal judge sided with the states in 2021, finding that the provision is “a federal invasion of state sovereignty.” The federal government appealed, landing the case before the 11th Circuit in September.

The appeals court upheld the Alabama judge’s decision on Friday, ruling that it is not enough for states to know that there are strings attached to federal funds — they must also fully understand the obligations of the deal.

"We remain unable to surmount the linguistic hurdle before us––because of the fungibility of money, Rescue Plan funds could conceivably 'indirectly offset' any reduction in net tax revenue caused by a change in law," Brasher, a Trump appointee, wrote, adding that the provision "alters the traditional balance of federalism by imposing a condition on a state’s entire budget process."

What does the phrase “directly or indirectly offset” mean? Brasher wrote that the panel agrees with the states that the phrase “seems ‘extraordinarily expansive,’” noting that “an indirect offset could be boundless.”

“We simply cannot pin down when an offset becomes attenuated enough to no longer be ‘indirect,’” the ruling states.

The panel also rejected arguments proffered by a Justice Department attorney that any confusion about the provision was cleared up by a regulation issued by the Treasury Department last year. The regulation assured states that Treasury Secretary Janet Yellen does not intend to enforce the provision to recoup money based on tax cuts so long as states can pay for the tax cuts using their own funds.

But the appeals court ruled that even a narrow reading of the provision represents an “unconstitutional condition” on federal funds.

In any case, the plan fails to provide a baseline or other way to determine whether net tax revenue have been reduced, the decision says.

Brasher was joined on the panel by fellow Trump appointee U.S. Circuit Judge Robert Luck and Senior U.S. Circuit Judge Ed Carnes, a George H.W. Bush appointee.

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