WASHINGTON – Arizona cut income taxes by $1.9 billion months after it sued the federal government over rules about how much states that accept federal COVID-19 relief funds can reduce taxes.
Hawaii is devoting more than 40% of its $1.64 billion in federal pandemic recovery aid to preventing higher payroll taxes on businesses – a move some argued didn't do enough to help workers.
Louisiana allocated nearly 20% of its $3 billion in American Rescue Plan funds to transportation construction and maintenance after an effort to raise the state’s gas tax sputtered.
"No one wanted to do it at this time because of that type of investment coming from the federal dollars," said state Rep. Jack McFarland.
A USA TODAY review of how states are starting to spend the $195 billion in direct aid included in a March coronavirus relief package found many are using large chunks of the help to avoid hiking taxes on businesses, drivers and others.
In addition, the massive amount of federal aid of various kinds since the pandemic started has boosted the economy and put many states in a strong enough budget position that they've been able to cut taxes.
“One of the sad lessons of the Great Recession was, we passed one stimulus bill and then all these state, local governments had all these problems still going on,” said Richard Auxier, a senior policy associate in the Urban-Brookings Tax Policy Center. “They became an actual drag on the economy as they had to cut programs or raise taxes to get back out of the hole that they had dug. And we didn't want to repeat that.”
Louisiana, which reduced its budget as much as possible after the coronavirus hit to prepare for the worst, ended up with a surplus after the first wave of pandemic relief funds for states, businesses and individuals, McFarland said.
He appreciates the "once in a lifetime" investment in the state's backlogged infrastructure needs but worries that all the federal spending could lead to inflation.
"I’m concerned that when this influx of federal money ends, what will our economy look like?" he said.
More help than during the Great Recession
The amount of all assistance that’s gone to state and local governments since the pandemic started is about three times the help Washington sent during the Great Recession.
Many states are still deciding how to spend their share of the $1.9 trillion American Rescue Plan, a largess that Republicans argued was unnecessary because of the substantial federal spending that had already occurred.
While states have flexibility in how they can use the money, the plan prevents states from offsetting a reduction in net tax revenue or from delaying a tax increase.
Treasury Secretary Janet Yellen has acknowledged that the "fungibility of money" makes an offset hard to define, but she's reassured states that nothing in the law prevents them enacting "a broad variety of tax cuts.”
It does mean states can’t cut net revenue below pre-pandemic levels unless they can show they did so without using American Rescue Plan funds.
Nearly half the states are challenging the rules as too restrictive.
“It is unacceptable for the federal government to commandeer states’ tax policies and micromanage their budgets,” Arizona Attorney General Mark Brnovich said in a March statement when filing his suit against the U.S. Treasury Department.
Still, the budget Arizona Gov. Doug Ducey signed into law last month includes $1.9 billion in tax cuts.
Katie Conner, a spokesperson for Brnovich, said the state's suit is necessary because the courts "must provide certainty" for states about a restriction "that should never have been included in the American Rescue Plan Act.”
About half the states have cut taxes
Auxier calculated that roughly half the states have passed a major tax cut this year.
“There were still tax increases here and there, but tax relief has been the primary focus of state legislatures in 2021,” Jackson Brainerd, a senior policy specialist with the National Conference of State Legislature’s Fiscal Affairs Program, recently wrote.
Republican states are reducing income taxes, a perennial priority for the party.
Both Democratic and Republican states are expanding their earned income tax credits, which help low-income workers most likely to have been hurt by the pandemic.
“This rule was never about stopping state tax cuts,” Auxier said, particularly for states doing well financially. It was about making sure states in dire fiscal situations used the money on programs related to the pandemic and not on tax cuts, he added.
It was also about preventing large tax hikes and big spending cuts to balance state budgets.
“What we have heard from several Democratic and Republican governors and mayors is that even before funds have gone out the door, many have avoided layoffs, painful service cuts and increases in business taxes because they knew the American Rescue Plan funds were there or on the way,” said Gene Sperling, who is overseeing implementation of the $1.9 trillion package.
Fewer state budget cuts
While most states had to make midyear budget cuts in the aftermath of the Great Recession, only a dozen had to during the 2021 fiscal year, according to the National Association of State Budget Officers.
Alaska, which was the furthest behind among states in revenue recovery after the first quarter of the year, is using $250 million of its $1 billion in federal aid to narrow the shortfall in its general fund. More than $44 million is being sent to local governments to make up for shared revenues – such as taxes on fisheries and cruise ships – that significantly decreased during the pandemic.
Without that revenue, the choices are “spending from emergency reserves that are dwindling, reduce service overall, delay or eliminate public infrastructure maintenance,” said Nils Andreassen, executive director of the Alaska Municipal League.
Improving roads without raising gas taxes
Replenishing transportation funds is another common use of the recovery dollars, which states can do if they are making up for revenue losses attributed to the pandemic.
Washington state is using $600 million to backfill transportation revenue losses caused by the pandemic. Some of that will cover a drop in tolls collected on State Route 520, the world’s longest floating bridge. The federal funding will keep toll rates from rising.
Colorado is using $36.5 million to make up a revenue loss from temporarily reducing vehicle registration fees and fines. That reduction was part of a tradeoff in a major transportation initiative that includes new gas and road usage fees.
“We now have an opportunity to create a solution that saves people money right away by reducing vehicle registration fees and works for the Colorado of tomorrow, including creating cleaner air and more efficient transportation,” Gov. Jared Polis said in a May statement when the package was introduced.
The federal aid will compensate state and local governments that had been expecting a share of the vehicle registration fees.
Louisiana, which hasn’t raised its gas tax in decades, is spending $563 million of its $3 billion in American Rescue Plan funds on transportation construction and maintenance.
Easing tax burdens on employers
Louisiana is also among the many states pouring a large chunk into their unemployment insurance trust funds, which are usually filled through payroll taxes on employers and which are used to pay out unemployment benefits.
Almost half of the states have already used some of the coronavirus relief money they got in 2020 to bolster their trust funds, according to the National Federation of Independent Business. The group has urged states to “maximize the unrestricted federal funding” in the American Rescue Plan to help their trust funds.
More than half the states are planning to do so, according to a May review by the Associated Press.
“I think that many states are prioritizing replenishing them after seeing large increases in unemployment claims during the pandemic,” said Brian Sigritz, director of State Fiscal Studies at the National Association of State Budget Officers. “States are trying to prevent tax increases on businesses during the economic recovery, while at the same time attempting to avoid increased borrowing costs.”
As of mid-July, 17 states owed more than a combined $54 billion to the federal government for loans taken out to pay unemployment benefits after their trust funds were depleted.
Extra taxes kick in if states can’t repay their loans within a certain amount of time.
Even states that don’t have loans to repay need to replenish their trust funds.
In Maryland, which owes more than $68 million to the federal government, businesses knew the per-employee tax rate could not go back to its lowest rate.
“We were just trying to stave off what would be a drastic increase,” said Andrew Griffin, vice president of government affairs for the Maryland Chamber of Commerce.
After the American Rescue Plan became law, the Republican governor and Democratic legislature quickly agreed to a budget that included using $1.1 billion of the $3.7 billion in federal aid on the trust fund. Other chunks of funding went for various programs to help Marylanders in need. Maryland is among the states that expanded its earned income tax credit.
But Maryland is also among the states that want to end early the extra unemployment benefits provided by the federal government during the pandemic, a move halted by a state judge this month.
The National Employment Law Project has asked the federal government to block states from cutting unemployment benefits if they’re spending some of their federal aid on the program.
“If you want to put some of it in the trust fund in order to expand your unemployment insurance benefits – raising the weeks people get, the amount of wage replacement – then that would be great,” Jenna Gerry, the organization's senior staff attorney, told USA TODAY. “But that's simply not what we're seeing.”
'Does that translate into jobs?'
In Hawaii, Democrat state Rep. Roy Takumi was one of the few lawmakers who objected to the decision to spend $700 million of the state’s $1.64 billion in federal aid on the unemployment insurance trust fund.
“I just felt we should have shared that benefit,” said Takumi. He wanted some of the money to be used to exempt unemployment benefits from state income taxes.
The union that represents hospitality, health care and food service workers in Hawaii wanted the funding to come with a requirement that hotels and other employers hire back those who had been laid off.
“When the government is handing out things to business, OK, but does that translate into jobs – which is what should be happening,” said Eric Gill, financial secretary-treasurer of Unite Here Local 5.
Sherry Menor-McNamara, who heads Chamber of Commerce Hawaii, said many businesses would not have survived if the state had to revive its trust fund hole solely through higher taxes on employers.
“The idea was to help save businesses so businesses can continue to provide the jobs,” she said.
Gerry, of the National Employment Law Project, said the underlying problem is states underfunded their trust funds for years.
“After the last recession, states were encouraged by the Department of Labor to raise taxes in order to … make sure that these unemployment insurance trust funds were solvent during times of recession,” she said. “And states simply did not do that.”
California businesses want more help
The debate over whether to spend federal rescue dollars replenishing the trust funds is ongoing in California, which owes Washington about 40% of the more than $54 billion in outstanding loans.
Gov. Gavin Newsom proposed using $1.1 billion of the state’s $27 billion in direct aid for the trust fund. Some lawmakers wanted instead to spend $2 billion on payroll tax credits to small businesses to offset higher unemployment insurance taxes.
The budget approved in June included neither, despite a record budget surplus.
Rob Lapsley, president of the California Business Roundtable, has been trying to get the governor and state legislature to set up a working group with businesses to resolve the issue.
Lapsley's group notes that it took nearly 10 years for the state to pay off the federal loan to the trust fund incurred during the Great Recession, a debt less than half the size of the current loan.
“We are now facing the largest tax increase on California businesses in history,” Lapsley said, “because there is literally no discussion going on from the legislature or the governor’s office on how to be able to pay this off.”
This article originally appeared on USA TODAY: States cutting taxes, avoiding rate hikes after federal stimulus