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State and Local Tax

Eleventh Circuit Finds ARPA Tax Mandate Unconstitutional, Upholds Permanent Injunction Against Enforcement

by Denis Del Bene

The Eleventh Circuit (the Court), affirming the U.S. District Court for the Northern District of Alabama, has held that that the tax mandate provision in the American Rescue Plan Act of 2021 (ARPA) is an unconstitutionally ambiguous condition on states’ receipt of federal funds. The Court also found that the district court did not abuse its discretion in granting the plaintiff states’ motion for a permanent injunction enjoining enforcement of the tax mandate provision. (State of West Virginia, et al. v. U.S. Dept. of Treasury, et al., U.S. Ct. App. (11th Cir.), Dkt. No. 22-10168, 01/20/2023.)

Background.

The ARPA, Pub. L. No. 117-2 (42 U.S.C. §§ 802 et seq.) is a $1.9 trillion economic stimulus bill aimed at mitigating the economic and public health effects caused by the coronavirus pandemic that was passed by Congress and signed into law by President Joe Biden on March 11, 2021. ARPA distributes roughly $195.3 billion directly to the states for specified purposes. Before a state can receive those funds, it must certify to the U.S. Secretary of the Treasury that it will comply with multiple conditions that ARPA imposes.

The plaintiff states contend that one of those conditions, the offset provision (the “Tax Mandate”), exceeds Congress’s authority under the Spending Clause of Article I, Section 8 of the U.S. Constitution. The Tax Mandate provision of ARPA provides that, “a State or territory shall not use the funds provided…to 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) or delays the imposition of any tax or tax increase.” The phrase “directly or indirectly offset” is not defined in ARPA. The U.S. Treasury Secretary can recoup funds that she interprets were used in violation of the Tax Mandate. The Tax Mandate’s “covered period” extends from March 3, 2021, until all funds have been expended or returned to, or recovered by, the U.S. Treasury Secretary.

On March 31, 2021, 13 states sued the Treasury Department, Treasury Secretary, and Inspector General of the Treasury Department in the U.S. District Court for the Northern District of Alabama, challenging the offset provision. The 13 states were Alabama, Alaska, Arkansas, Florida, Iowa, Kansas, Montana, New Hampshire, Oklahoma, South Carolina, South Dakota, Utah, and West Virginia. The states argued that this tax mandate exceeds Congress’s authority under the Constitution. The complaint averred three claims: first, that the offset provision is an unconstitutionally ambiguous and coercive condition under the Spending Clause; second, that the offset provision violates the Tenth Amendment’s anti-commandeering doctrine; and third, that the harms alleged in the first two counts entitle the states to declaratory relief.

On May 17, 2021, the Treasury Department issued an interim final rule to clarify ARPA’s contours and scope. Recognizing that money is fungible, the interim final rule creates a framework for deciding whether a state has improperly offset a reduction in net tax revenue with ARPA funds. The rule makes clear that failure to comply with the offset provision’s restrictions on use may result in recoupment of funds and provides a detailed recoupment procedure. The rule also sets a net tax revenue baseline for judging compliance with the offset provision at “fiscal year 2019 tax revenue adjusted for inflation.” It provides a 4-part process to determine whether, and the extent to which, ARPA funds have been used to offset a reduction in net tax revenue as compared to the 2019 baseline. The rule prohibits recipient states from offsetting reductions in net tax revenue by cutting spending in an area where they had spent ARPA funds. The final rule, implemented on January 27, 2022, did not materially differ from the interim rule.

On November 15, 2021, the U.S. District Court for the Northern District of Alabama held that the tax mandate provision of ARPA was an unconstitutionally ambiguous condition on the states’ receipt of federal funds and granted the plaintiff states’ motion for a permanent injunction enjoining enforcement of the tax mandate provision. The district court did not reach the states’ coercion and anti-commandeering concerns. Nor did it enter a declaratory judgment for the states because it deemed the permanent injunction would fully rectify the harm.

Standing.

The Court concluded that the states had standing, noting that the constitutional minimum of standing requires three elements: (1) an injury in fact that is concrete and particularized and actual or imminent; (2) a causal connection between the injury and the conduct complained of; and (3) redressability.

As to the first element, the Court noted that the states had two theories for why they suffered actual and concrete harm. First, the states argued that their inability to ascertain the condition imposed by the offset provision had already infringed, and continued to infringe, on the states’ sovereign prerogatives as parties to a contract with the federal government. Second, the states argued that they were subject to the threat of a recoupment action if they spent funds contrary to the offset provision. The Court agreed that these theories established that the states had suffered an injury-in-fact. As to the second and third elements, the Court noted that the states injury is fairly traceable to the challenged conduct, namely, the promulgation and enforcement of the allegedly unconstitutional offset provision. This injury is plainly redressable by declaring that provision null and void.

The Treasury Department argued that, even if the states had standing to file this suit initially, it had become moot. The Treasury Department said that it had disclaimed the broad reading of the offset provision that would stop the states from cutting taxes and did not intend to enforce the provision to recoup money based on tax cuts as long as the states can pay for the tax cuts using their own funds. The Trasury Department explained that it had formalized this reading of the offset provision in the Treasury regulation issued. The Court, however, concluded that the regulation did not moot the states’ challenge. The Court reasoned that even if the Department gave the offset provision a narrow reading, the offset provision would continue to limit how the states may use federal funds. To the extent the limitation was unascertainable, it remained an unconstitutional condition on those funds.

ARPA offset provision violates Spending Clause.

The Court agreed with the states’ argument that the offset provision violates the Spending Clause of the U.S. Constitution because the states cannot ascertain the condition it imposes on ARPA funds. The Court found the condition imposed by ARPA’s offset provision was not ascertainable and did not provide clear notice about how to comply with it, rendering it unconstitutional.

The Spending Clause authorizes Congress to “lay and collect taxes… to pay the debts and provide for the common defense and general welfare of the United States.” This clause gives Congress a wide berth not only to tax and spend but also to exert influence on the states by attaching strings to federal funding. Congress may, within limits, compel states to take certain actions that it could not otherwise require them to take, and a state’s acceptance of the federal funds will generally constitute consent to the conditions imposed by Congress. In Pennhurst State School and Hospital v. Halderman451 U.S. 1 (1981), the Supreme Court held that, by virtue of the Spending Clause, Congress can amplify its enumerated Article I powers and influence state regulatory policy by “fixing the terms on which it shall disburse federal money to the States.” But the Supreme Court recognized this broad authority is not limitless, and Congress must speak unambiguously and with a clear voice when it imposes conditions on federal funds. Specifically, Congress must speak clearly enough for “the states to exercise their choice knowingly, cognizant of the consequences of their participation.” The Supreme Court explained that a state cannot knowingly accept a condition if it is unable to ascertain what is expected of it.

The Court noted that there were three aspects of ARPA that, when combined, were inconsistent with the constitutional imperative that Congress’s funding conditions be ascertainable. First and most importantly, the offset provision did not provide a standard against which a state could assess whether it will reduce or has reduced net tax revenue. The prohibition on any “reduction in the net tax revenue” presupposes a baseline against which to measure a potential reduction. Although the Secretary’s rule supplies a benchmark, the ARPA itself does not provide any way to determine whether net tax revenues have been reduced. This lack of a baseline affects whether a state policymaker can understand and comply with the statute. Without a baseline, there is no way to assess whether a tax cut has caused a “reduction in the net tax revenue.”

Second, ARPA’s prohibition against either directly or indirectly offsetting net tax reductions with recovery funds exacerbates this ascertainability problem. The Court noted that ARPA does not define “directly or indirectly” and that it agreed with the states that the phrase “directly or indirectly offset” seemed extraordinarily expansive. Because money is fungible, the Secretary could always assert a plausible argument that a state, after a tax cut, committed an unlawful indirect offset of the attendant revenue shortfall. Because ARPA funds could conceivably indirectly offset any reduction in net tax revenue caused by a change in law, the Rescue Plan leaves them guessing whether and how they can spend ARPA funds after the tax cut.

Third, the Court noted that it could not ignore that Congress had aimed this novel restriction at each state’s entire budget and every single one of its taxes. The states face billions of dollars in potential recoupment actions and must ensure that every tax and tax rate comply with this condition. The Court reasoned that ARPA’s novelty and scope made it even more important that Congress speak with a clear voice.

Other constitutional claims.

Because of its finding that the condition imposed by ARPA’s offset provision violated the Spending Clause for its lack of ascertainability, the Court reasoned that it need not address the states’ coercion and Tenth Amendment claims.

Permanent injunction.

To obtain a permanent injunction, the moving party must show that: (1) it has suffered irreparable harm; (2) remedies at law will not provide adequate compensation for the injury; (3) on balance, an equitable remedy is warranted; and (4) a permanent injunction will not disserve the public interest. Applying this standard, the Court found that the district court did not abuse its discretion in concluding that a permanent injunction was warranted.

The Court reasoned as follows: First, the states have suffered irreparable harm. ARPA’s offset provision affects 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. Second, money damages cannot adequately compensate the states because the federal government generally enjoys immunity from suit. Third, the states’ inability to promulgate their own tax policies, and the attendant financial consequences, outweigh any inconvenience to the Treasury Secretary from the district court’s injunction. Fourth, the injunction serves the public interest. Enforcing the Spending Clause’s limitations helps preserve state sovereignty and the two-government system established by the Framers. All four elements weigh in favor of granting a permanent injunction.

Declaratory relief unnecessary.

The Court agreed with the district court that since the permanent injunction fully redresses the states’ harm in this case, declaratory relief was unnecessary. The Court stressed that the permanent injunction applies only to the offset provision of ARPA, which is severable from the remaining provisions of the Act.

 

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