ARPA Litigation has Sales Tax Implications

Vertex Inc.

Could two dozen or more U.S. states be forced to repay misused American Rescue Plan Act (ARPA) funds to the federal government? Will the stipulations governing how states are to use the $195.3 billion the ARPA hold up in circuit courts, or possibly even the U.S. Supreme Court? 

The answers to those and related questions could have major implications on future state sales tax base and rates.

President Joe Biden signed ARPA in March 2021. The $1.9 trillion federal stimulus bill included a combined $350 billion in emergency funding for state, local, territorial and tribal governments. These public entities were instructed to obligate the funds by Dec. 31, 2024, and spend them by Dec. 31, 2026. The final bill stipulates that the Coronavirus State and Local Fiscal Recovery (SLRF) Funds may be used to

  • Respond to the public health emergency or its negative economic impacts;
  • Respond to workers performing essential work during the pandemic by providing premium pay; 
  • Cover the “provision of government services to the extent of the reduction in revenue due to the COVID–19 public health emergency relative to revenues collected in the most recent full fiscal year prior to the emergency;” and
  • Make necessary investments in water, sewer, or broadband infrastructure.

The US Treasury released its final rule on the related for the Coronavirus State and Local Fiscal Recovery Fund program on January 6, 2022, which became effective April 1, 2022, and it provides additional clarity and flexibility on uses and application.   

The U.S. Congress also specified two uses of the funds that are prohibited, and this is where it gets contentious and litigious. SLRF funds cannot be used for:

  • For deposits into any pension funds; or
  • To offset a reduction in net tax revenue resulting from a change in law, regulation, or administrative interpretation.  It is this [constitutionally] controversial provision in the Act, a/k/a - the “Tax Mandate,” which prevent states from using ARPA funds “to either directly or indirectly offset a reduction in the net tax revenue through the end of 2024,” that is sparking the federal constitutional tax challenges.  

Some tax reductions are permitted as long as a state’s tax revenue for a given reporting year is no more than 1% less than that state’s fiscal year 2019 tax revenue, adjusted for inflation.  However, If a state misuses the funds – based on whether it adhered to the bill’s stipulations – the federal government can recoup those funds.  States argue that Congress exceeded its authority by attaching conditions in the Tax Mandate that are vague and ambiguous. They assert that rule bars states from passing their own tax relief measures, hence, making it difficult for states to exercise their own suitable selections in the use of the funds.

Since the bill was signed in March 2021, more than 20 states – including Florida, Texas and West Virginia -- have challenged ARPA’s so-called tax mandate and the federal government’s ability to recoup funds in courts.  Although there have been some setbacks due to lack of standing, such as the Missouri v. Yellen petition, for the most part, states are winning.  Thus far, they have been successful in blocking the tax mandate enforcement, by federal courts ruling that tax mandate is unconstitutional.  Last month, the federal district court Alabama ruling in favor of 13 states, held that the unclear vague language of the tax mandate provision contained in the Act (ARPA), is unconstitutional, as it attempts to prohibit states from cutting taxes, and exercising their own choices.  Also on November 18th, affirming the decision of the US District Court the 6th Circuit Court of Appeals, also ruled the tax mandate unconstitutionally “vague and ambiguous” under the Spending Clause. 

Depending on how the courts rule, states may or may be able to apply ARPA funds to reduce or offset taxes. Some states have already passed legislation to reduce personal income tax rates and corporate income rates. If any of these reductions are determined to violate ARPA stipulations, the federal government could “claw back” ARPA funds, creating revenue gaps that many, if not most, affected states would consider closing via sales tax rules changes and/or rate increases. 

The Potential State Tax Consequences of the ARPA Litigation 

Given the Constitutional significance of the ARPA state cases currently pending in federal appeals courts,   it was only a matter of “timing” before the appeal went to the US Supreme Court.  On December 14th, the appeal of the case Missouri v. Yellen was filed in the US Supreme Court.  However, on January 17th , the Court rejected the petition for review of the Eight Circuit Court of Appeals, thus, re-affirming the ruling that Missouri lacked standing, by ruling that the state wasn’t challenging the actual offset provision as written but rather the hypothetical broad interpretation of the provision and had not suffered an injury under either the broad or the narrow interpretation of the provision.    Even so, and on another judicial turn, on January 20th , in the case of W. Virginia and 13 States) v. US Treasury , the 11th Circuit held that the states did have standing, and that the “tax mandate” was unconstitutional as written re-affirming the permanent injunction from the US District Court.  The 11th Circuit distinguished its case from the 8th Circuit case, denied by the Supreme Court, in that the states did not challenge the tax offset provision as written, but rather challenged a specific potential interpretation of the provision.    

However, aside from the various and significant constitutional issues in the state’s case, the ARPA state litigations also have economic and tax policy importance at this moment of economic turmoil.  Over time, inflation is also “tax upon taxes.”  As inflation rises and recession looms, whether mild or moderate, the cost of goods and services increases for all, including state, local governments, and taxpayers.  In turn, this affects a state’s tax base or tax rate.  When prices increase, cost rises, and most taxes are impacted.  However, in particular, sales tax is directly connected with prices and inflation, as the levy is a percentage of sales transactions.  Accordingly, as costs are ultimately passed on to consumers, states are collecting higher taxes due to the increase in prices, thus, higher sales taxes.  This is a distortion that appears as if states are collecting more tax revenue when in fact, they are not.  At the same tax rate, state and local governments are also spending more to provide public services; hence, tax rates and bases must be adjusted appropriately.  Supplementing rate reductions, states also expand their sales tax base while modifying losses, exemptions, credits, deductions, and other tax attributes specific to economic benefits, which under ARPA, may be subject to review for possible claw-backs and returns of funds to the federal government.

Consequently, during this economic downturn, several states are reducing taxes to relieve taxpayers from inflation and a potential coming recession while retaining as much Covid- pandemic recovery funds as possible in their Rainy-Day Funds as possible, to balance their budget during difficult economic times.  

Tax departments and professionals should consider the state's budget and fiscal conditions, as well as the regional tax instability that would reasonably follow, should the Treasury win the ARPA challenge in the SCOTUS and demands the return of ARPA recovery funds to the federal government.  Then, consider this same development under a moderate-to- deep recession.

1 Final Rule, Coronavirus State and Local Fiscal Recovery Funds, Department of the Treasury, 31 CFR Part 35, RIN 1505-AC77], 2022. 
2 Commonwealth of Kentucky and State of Tennessee v. Janet Yellen et al., No. 21-6108, United States Court of Appeals, Sixth Circuit, November 18th, 2022.
3 National Conference of State Legislatures NCSL), Supreme Court Declines to Hear ARPA Case, Will Take Up Religious Accommodation, January 23, 2023,  
4 USCA 11th Circuit Case: 22-10168, 01/20/2023
5 National Conference of State Legislatures NCSL), January 23, 2023, Ibid.

Blog Author

George L. Salis, Principal Economist and Tax Policy Advisor at Vertex Inc.  Vertex's Chief Tax Office (CTO) provides insight regarding the impact of tax regulations, policy, enforcement, and emerging technology trends on global tax department operations.

George L. Salis

Chief Economist and Senior Tax Policy Director

See All Resources by George

George L. Salis is Chief Economist and Senior Tax Policy Director. He is an economist, lawyer, and tax professional with 29+ years’ experience in international taxation and trade compliance, tax planning and controversy, fiscal regulation, and tax economics consulting. He is responsible for analysis of economic, fiscal, legal, trade, and development issues in countries, as well as tracking and analyzing the rapid change in tax policies and regulations, and inter-governmental organizations, and tax administrations around the world.

George is the recipient of the Advanced Certificate in EU Law from the Academy of European Law, European University Institute in Florence, and the Executive Certificate in Economic Development from the Harvard Kennedy School of Government.

George received his BSc in economics and political science, an LLB (Honours), an MA in legal and ethical studies, and an LLM (Honours) in international tax law. He also holds the PhD in international law and economic policy, and the SJD in Taxation from The University of Florida, Levin College of Law. George is a Certified Business Economist (CBE- NABE).

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