The Corner

Economy & Business

The Ban on State Tax Cuts: An Update

As I’ve noted previously, the latest COVID bill gives states far more money than they need to offset their declines in tax revenue, and then tells them they can’t use that money to cut taxes — even “indirectly.” Some states quickly sued over this vague and sweeping prohibition. And now the Treasury Department is issuing a rule to lay out its interpretation of the law.

Jared Walczak of the Tax Foundation has a good primer on the 151-page document. The rule clarifies that tax cuts will be measured relative to the 2019 fiscal year, so if a state brings in more revenue than it did that year (adjusting for inflation), it will be safe from claims that it used COVID money to cut taxes.

But the rule could still stop states from passing sensible tax cuts, even if those cuts are not, in reality, funded by federal COVID cash. Walczak notes, for example, that it could prove difficult for states to fund tax cuts with spending cuts:

Essentially, reductions in spending cannot be in any area where the state government has spent Fiscal Recovery Funds—determined at the department, agency, or authority level. This is true even if the budget reductions financing a tax cut are in no way being offset by Fiscal Recovery Funds, provided that any of those funds are used elsewhere in the department in equal or greater amount. . . .

Imagine if, for instance, a state reduces the size of its drug enforcement budget within law enforcement and corrections agencies following the legalization of marijuana. At the same time, suppose that the Department of Corrections uses federal dollars to treat coronavirus cases in prisons, or the Department of State Police uses funding to offset salaries or provide supplemental pay for officers. In neither case would these federally financed expenditures in any way offset the savings from reduced drug enforcement, yet it appears that the federal government would prohibit using these savings to help finance a tax reduction, since they coexist in the same department or agency.

Giving states tons of money they don’t need is bad policy. Using that money as leverage to meddle in state policymaking is even worse. And the incompetency of the meddling thus far only compounds the error.

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