One of the more controversial provisions of the massive federal COVID relief American Rescue Plan Act (ARPA) is the prohibition against states offsetting tax cuts with federal bailout dollars. Many viewed these provisions as violations of basic principles of federalism, and the issue is being worked out in the courts.

In general, the CEA is sympathetic those arguments that Congress overreached with its efforts to keep states from reforming their tax codes in any way that would reduce tax revenues in the short term. However, state economic development tax abatements are a special case in this regard, as they are specifically and inherently a question of states engaging in efforts to influence interstate commerce. That’s a matter the Constitution specifically gives Congress the power to regulate, which puts a connection between federal COVID bailouts and state economic development tax abatements on firmly enumerated Constitutional footing.

It’s just good policy to keep the federal government from funding all sides of states’ corporate welfare race to the bottom, and we were saying so months before the passage of ARPA. Early in the pandemic, CEA President John Mozena and Mercatus Center Research Fellow Michael D. Farren had proposed just this kind of model for federal action, in their Mercatus Center working paper “Federal Pandemic Relief Could End the Interstate Economic Development Arms Race.” Farren and Mozena called for the federal government to make any state budget bailout contingent on states’ agreement to end their use of targeted economic development subsidies.

In ARPA, Congress created the Coronavirus State and Local Fiscal Recovery Funds, which had the stated dual purposes of offsetting state spending on COVID response and helping accelerate the economic recovery from the pandemic and associated disruptions to economies. But while Farren & Mozena’s proposal had limited bailout restrictions solely to ending economic development tax breaks, ARPA’s language was far broader, arguably prohibiting states from virtually any form of tax cut that would result in a net loss of tax revenues to the state:

A State or territory shall not use the funds provided under this section or transferred pursuant to section 603(c)(4) 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.

States quickly sued to block implementation of these provisions, but a final outcome rests on the U.S. Treasury Department’s adoption of a “Final Rule” that clarifies how the federal government will define and enforce this provision in practice. And while the CEA focuses our work tightly on state and local policy issues, the Treasury’s final rule has huge implications for what forms of economic development subsidy programs state and local governments may be able to operate over the next four years.

That’s why the CEA submitted an official public comment on the interim final rule, supporting language that would clearly include new targeted economic development subsidies within the definition of tax breaks that could not be offset with federal COVID relief funds. You can read our comment below, or on the website.

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