Court: State has right to challenge provision on tax cuts, COVID funds

PHOENIX – Arizona has a legal right to challenge a provision in the federal COVID relief package that forbids using the money for tax cuts, a federal appeals court ruled Thursday.

The judges of the 9th Circuit Court of Appeals rejected arguments by the Treasury Department that Congress has absolute power to set conditions on receipt of federal funds and that Arizona was free to turn away the estimated $4.9 billion it got from the American Rescue Plan Act if it disagreed. Judge Ronald Gould, writing for the panel, said Arizona is legally entitled to claim that the conditions are “unconstitutionally vague or coercive.’’

He also said the state, by virtue of enacting a $1.9 billion tax cut in 2021, has standing to get a ruling as to whether the provision attached to the ARPA funds is legal. In fact, Gould said, Arizona doesn’t even have to admit that it actually used the COVID dollars to finance any of that to challenge the federal law.

Thursday’s ruling, however, does not end the matter. Instead, it sends the case back to the trial judge who originally threw it out of court, directing her to decide if the rules illegally infringe on state sovereignty.

At the heart of the battle is language in the federal law that says states cannot use the money they are getting from the feds “to either directly or indirectly offset a reduction in the net tax revenue of each state.’’ That includes any change in state law or regulation that reduces rates or provides rebates, deductions or credits.

Any violation results in the state having to repay the government any reduction in taxes.

The problem, argued Attorney General Mark Brnovich, starts with what he said is the vagueness of the language, particularly the part of about indirectly offsetting tax cuts.

What makes the issue important for Arizona, he said, is that the state’s fiscal fortunes have changed.

On one hand, during the second quarter of 2020 – right as the virus hit and portions of the economy were closed – state revenues came in well below projections. That led lawmakers to craft a lower spending plan for the following fiscal year.

But what happened, Brnovich said, is that collections in two areas were been greater than expected.

First was a change in state law that now allows Arizona to collect sales tax from online retailers. Then there was a big increase in contracting and the taxes that go with it.

The result, he said, was a surplus that lawmakers and Gov. Doug Ducey used for tax cuts, regardless of the COVID dollars.

Beyond that, Brnovich argued that precluding legislative tax cuts to get the federal dollars puts Arizona in a no-win situation.

“States are in no position to turn down the federal government’s offer given their financial situations, which have been significantly strained by the COVID-19 pandemic,’’ he said, pointing out that Arizona’s share amounts to close to 40% of the state general fund budget.

U.S. District Court Judge Diane Humetewa threw out the case.

She said Brnovich’s claim of how the “ambiguity’’ in the federal law left legislators uncertain of how to comply rang hollow as it never kept them from approving that $1.9 billion tax cut package.

Gould acknowledged that Arizona has not conceded used any of the ARPA funds to finance all or part of the tax cut.

“Presumably, a $1.9 billion tax cut will lead to a reducing in Arizona’s net tax revenue,’’ he wrote. “It is hard for us to imagine how a tax cut of this magnitude would not.’’

But he said that’s not relevant to the case – or the state’s ability to sue over the restriction. “We do not require Arizona to explicitly confess to intended future conduct that is violative of the law it seeks to challenge,’’ he wrote.

On top of that Gould said the federal government has not said it won’t try to come after Arizona if it eventually concludes that the state violated the restriction on using the funds for tax cuts or other revenue reductions. That, he said, makes it a live threat which provides the state with a legal right to seek court relief.

Still, Gould suggested that the state may have a problem ultimately winning its case.