Missouri sues over tax cut penalties in federal COVID-19 relief bill

Missouri on Monday became the first state to challenge a punitive provision of the $1.9 billion federal COVID-19 relief bill signed early this month by President Joe Biden.

In a lawsuit filed in federal court in St. Louis, Attorney General Eric Schmitt is asking the court to limit how states could lose promised budget aid if they cut taxes. A March 23 letter from Treasury Secretary Janet Yellen doesn’t give states the confidence to set tax policy without being punished, Schmitt says in the lawsuit.

“The uncertainty created by Secretary Yellen’s response, and the prospect of Treasury imposing the broad interpretation of the Tax Mandate, threatens grave, immediate, and irreparable injury to the State of Missouri,” the lawsuit alleges.

Yellen, in her letter, defended the provision as part of well-established practices allowing Congress to enact “reasonable conditions on how states may use federal funding.” She also wrote that states would not trigger the punitive provision barring tax cuts “by replacing the lost revenue by other means…”

Yellen was responding to a March 16 letter from Republican attorney general 21 state attorneys general calling the tax penalty passed by the Democratic-controlled Congress into question. 

Schmitt’s lawsuit comes just a week after he formally launched a bid for the U.S. Senate, joining a potentially crowded GOP primary that already includes former Missouri Gov. Eric Greitens. His previous lawsuits against the Biden Administration were among the things he highlighted in announcing his candidacy.

Under the American Rescue Plan, Congress set up a fund of $195.3 billion for direct aid to states, territories and Native American tribal governments. Each state gets $500 million, plus a share based on unemployment in the last quarter of the year. Missouri expects $2.81 billion.

The act bars states from passing tax cuts that would be offset, “directly or indirectly,” by the new federal aid. The penalty is a loss of federal aid equal to the tax cut, or all federal aid under the law, whichever is less.

“The Act’s funds fill a large and urgent need in Missouri’s budget,such that Missouri has no real choice except to take the funds, especially while attempting to respond to the economic instability wrought by the COVID-19 pandemic,” Schmitt’s lawsuit states.

In a news release announcing the lawsuit, Schmitt said the federal bill forces states to choose to accept the money or lose sovereignty over tax decisions.

“Missouri should not have to choose between implementing tax policy or receiving federal COVID-19 relief funds, especially as this pandemic has crushed small businesses and individuals,” Schmitt said in the release.

There are numerous federal programs that require states to spend money in order to participate, such as highway construction and Medicaid, and many federal laws that punish states that do not pursue policies deemed desirable by Congress.

When Congress passed a law withholding 5 percent of federal highway funding from any state that did not raise its minimum drinking age to 21, the U.S. Supreme Court upheld the law as a “relatively mild encouragement” to follow the policy.

But when Congress passed the Affordable Care Act in 2010 and made expansion of Medicaid eligibility a requirement for continued participation in the original Medicaid program, the Supreme Court ruled that it had unconstitutionally moved beyond encouragement to coercion.

“In this case, the financial ‘inducement’ Congress has chosen is much more than ‘relatively mild encouragement’—it is a gun to the head,” Chief Justice John Roberts wrote in a 2012 ruling that made Medicaid expansion voluntary.

Schmitt cites both of those cases in the lawsuit filed Monday, arguing that anything but a narrow interpretation of the provision would be unconstitutional. He notes that state lawmakers are considering a variety of tax cuts ranging from tax credits for businesses suffering losses due to the pandemic to income tax cuts tied to overall state revenue growth.

Both chambers of the Missouri General Assembly have passed bills that include income tax cuts, but with provisions that will increase revenue through expanded collection of sales taxes from online retailers.

The House and Senate sponsors have said they don’t expect their bills to trigger the federal stimulus law’s penalty provisions. And one has said the effective date of the tax changes could be put off if there is any danger of losing federal aid due.

Yellen’s letter did not state how her department would interpret state tax cuts and asked the 21 attorneys general who signed a March 16 letter asking for clarity to wait for guidance that would be available before any state receives its money. 

“It is also important to note that states choosing to use the federal funds to offset a reduction in net tax revenue do not thereby forfeit their entire allocation of funds appropriate under this statute,” she wrote. “The limitation affects state’s ability to retain only those federal funds used to offset a reduction in net tax revenue resulting from certain changes in state law.”

This story was republished with permission from the Missouri Independent, a nonpartisan, nonprofit news organization covering state government, politics and policy.


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