On July 14, 2022, the U.S. Court of Appeals for the Eighth Circuit affirmed a district court ruling that Missouri lacked standing to challenge the controversial spending restriction on COVID-19 relief funds provided to the states under the American Rescue Plan Act (ARPA).1 In dismissing the case, the three-judge panel reasoned that the state did not face any “actual or imminent” injury in challenging the provision that prohibits states from using ARPA funds to offset net tax revenue reductions. Rather, the Court determined that Missouri alleged merely hypothetical harms that would result from the offset restriction based on its consideration of tax reduction polices. The decision potentially creates a split among the federal appeals courts on the issue of whether states have standing to challenge the ARPA offset provision.
In March 2021, President Joe Biden approved ARPA, a $1.9 trillion economic stimulus bill intended to mitigate the economic impact of the COVID-19 pandemic.2 Of these funds, Congress allocated over $350 billion for state and local governments to either use the funds for pandemic-related purposes or to make infrastructure investments.3
ARPA contains several restrictions on the ability of states to use the allocated funds. Notably, states cannot use the funds to offset a reduction in net tax revenue resulting from a change in law, regulation or administrative interpretation during a “covered period” that reduces any tax (referenced in the Eighth Circuit litigation as the Offset Restriction).4 The “covered period” began on March 3, 2021, and ends on the last day of the fiscal year in which the funds are used or returned to the federal government.5 States must comply with certification and reporting requirements in order to receive the funds.6 The federal government has the right to recoup the ARPA funds if the states are found to violate the Offset Restriction.7
In response to numerous requests for information on the scope of the Offset Restriction, the U.S. Treasury Department (Treasury) adopted an Interim Rule to provide further guidance on the implementation of the Offset Restriction.8 In January 2022, Treasury issued a Final Rule in substantially the same form as the Interim Rule, which became effective on April 1, 2022.9 The Final Rule generally provides that states are considered to impermissibly use ARPA funds to offset a reduction in net tax revenue where they fail to offset the reduction through means unrelated to ARPA funds.10 The Final Rule confirms that a reduction in net tax revenue could result from any “covered change,” including a change in law, regulation, or administrative interpretation that reduces any tax.11 However, the Final Rule clarifies that a covered change does not include changes that the state cannot control, or income tax changes simply conforming to changes in federal law.12
Shortly after the enactment of ARPA, Missouri challenged the “threatened unconstitutional application” of ARPA in the U.S. District Court for the Eastern District of Missouri.13 In its complaint, Missouri argued that two potential interpretations of the Offset Restriction exist. A narrow interpretation of the provision would prohibit states from using the funds to directly offset a specific tax reduction. In contrast, Missouri argued that a broad interpretation of the restriction may cause states to lose their ARPA funds if they enacted any tax-reduction policy that resulted in a net reduction of revenue during the covered period. Missouri alleged that Treasury declined to endorse the narrow interpretation of the Offset Restriction, thus generating “uncertainty, confusion and doubt for state legislatures that are currently considering and debating tax-reduction policies.”
After filing its complaint, Missouri moved for a preliminary injunction, asking the court to enjoin Treasury from applying the broad interpretation of the Offset Restriction. Missouri further argued that the Offset Restriction should be enjoined as an unclear condition on congressional appropriation in violation of the Spending Clause of the U.S. Constitution and the 10th Amendment. After a hearing, the district court dismissed the case, finding that Missouri lacked standing because it did not show that it suffered a concrete injury. Missouri appealed to the Eighth Circuit Court of Appeals.
Eighth Circuit decision
The Court began its analysis by stating that federal court jurisdiction is limited to cases and controversies.14 The jurisdictional requirement necessitates a thorough standing inquiry. Standing requires three elements: injury, a causal connection between the injury and the alleged conduct, and some likelihood that a decision will redress the injury.15
On appeal, Missouri explained five specific ways in which it was injured.16 The Court noted that Missouri challenged a specific potential interpretation of the Offset Restriction in challenging the constitutionality of the so-called “broad interpretation.” However, the Court determined that “there is no threatened application of the broad interpretation” based on Treasury’s statements made to the Court or based on anything found in its regulations implementing ARPA.
The Court next addressed Missouri’s argument that it risks forfeiting COVID-19 relief funds, some of which the state already received, under a broad interpretation of the Offset Restriction due to the state legislature’s consideration of tax-reduction policies. However, the Court noted that the consideration of tax cuts alone do not violate ARPA or Treasury’s interpretation of ARPA. Moreover, Missouri did not yet reduce net revenue, and did not claim to offset any proposed reduction in net revenue by means unacceptable to the U.S. Department of Treasury. In the Court’s view, Missouri failed to show that it had engaged in conduct that would lead to the recoupment of ARPA funds. Concluding that Missouri only alleged a “conjectural or hypothetical” injury, rather than one that is “actual or imminent,” the Court affirmed the district court’s ruling to dismiss the case for lack of standing.
With this decision, the Eighth Circuit becomes the second federal appeals court to rule on the issue of whether the states have standing to challenge the ARPA Offset Restriction. In May 2022, the U.S. Court of Appeals for the Ninth Circuit ruled that Arizona did have standing to challenge the Offset Restriction.17 Unlike Missouri, Arizona argued that the Offset Restriction was unconstitutionally ambiguous and unduly coercive. Contrasting Arizona’s challenge with that of Missouri, the Eighth Circuit suggested in a footnote that Arizona may have been more successful in its standing argument at the Ninth Circuit because it challenged the Offset Restriction as it was actually written, rather than a hypothetical broad interpretation of the restriction that according to the court was not adopted by Treasury. Though one could read the footnote as distinguishing the posture of the standing arguments raised by Arizona and Missouri in their respective cases, the Eighth Circuit’s dismissal of the case still creates a circuit split to the extent that both the states and the federal government have obtained relief in different appellate courts.
Separate from the standing issues at play, there are four additional state ARPA lawsuits that are all currently pending before other federal appeals courts and that also involve substantive issues regarding the constitutionality of the Offset Provision.18 In all of these cases, the lower district courts ruled in favor of the states, making Missouri v. Yellen the only case in which both the district and appellate courts have ruled in favor of the Treasury Department, albeit on the standing issue alone. In a related case decided after the Eighth Circuit’s decision, an Arizona U.S. District Court ruled that Treasury did not exceed its authority in limiting the ability of the Arizona governor from using ARPA funds to fund two specific education programs.19 Unlike the state cases challenging the constitutionality of the Offset Provision, the Arizona lawsuit represents the first instance in which Treasury has restricted the use of COVID-19 relief funds for specific programs based on its adoption of the Final Rule.
Based on the number of ARPA cases currently before the federal appeals courts, it is possible that at least one appellate court may rule on the substantive merits of the cases by the end of the year. At this stage of the litigation, the circuit split over standing and any potential conflicting rulings regarding the constitutionality of the Offset Restriction raise the possibility that the U.S. Supreme Court could opine on these issues if appealed, given the compelling issues raised by the restriction and the resulting impact on the future of state tax policy.
1 Missouri v. Yellen et al., No. 21-2118, U.S. Court of Appeals for the Eighth Circuit, July 14, 2022.
2 P.L. 117-2 (2021).
3 42 U.S.C. § 802(c)(1). Eligible pandemic related spending purposes include payments (i) in response to COVID-19 or its economic impacts, including assistance to households, small businesses, and nonprofits, or aid to impacted industries such as tourism, travel, and hospitality; (ii) for workers performing essential work during the pandemic; and (iii) for the provision of government services that may be impacted by COVID-19. Funded infrastructure improvements include investments in water, sewer, or broadband infrastructure.
4 42 U.S.C. § 802(c)(2). “A State or territory shall not use the funds provided under this section . . . 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.”
5 42 U.S.C. § 802(g)(1). As the funds obtained from ARPA must be spent by December 31, 2024, the ending date of the covered period could extend for several years.
6 42 U.S.C. § 802(d)(2).
7 42 U.S.C. § 802(e).
8 31 C.F.R. Part 35, RIN 1505-AC77, Coronavirus State and Local Fiscal Recovery Funds.
9 31 C.F.R. § 35.1 et seq.
10 In particular, the Final Rule provides specific examples of when the Offset Restriction is violated: (i) the state implements a law or regulation change that is predicted to have the effect of reducing tax revenue; (ii) the reduction is more than de minimis, meaning that it exceeds 1% of the state’s baseline tax revenue for 2019, adjusted for inflation; (iii) the state reports a reduction in net tax revenue; and (iv) the aggregate reduction is greater than the sum of other changes. 31 C.F.R. § 35.8(b).
11 31 C.F.R. § 35.3 (definition of “covered change”).
13 See Missouri v. Yellen, 538 F.Supp.3d 906, U.S. District Court for the Eastern District of Missouri, May 11, 2021.
14 See Wieland v. U.S. Dep’t of Health and Human Servs., 793 F.3d 949 (8th Cir. 2015).
15 See Carson v. Simon, 978 F.3d 1051 (8th Cir. 2020).
16 Specifically, Missouri argued that: (i) the broad interpretation of the Offset Restriction punishes the state for exercising the right to set taxes; (ii) Treasury’s embrace of the broad interpretation harms Missouri’s interest in the offer of funds provided by Congress; (iii) the Treasury regulations lead to greater compliance costs; (iv) there is an increased chance Missouri loses the ARPA funds under the broad interpretation; and (v) the state intends to engage in conduct with a constitutional interest but is prevented by statute with a credible threat of enforcement.
17 Arizona v. Yellen, No. 2:21-cv-00514, U.S. Court of Appeals for the Ninth Circuit, May 19, 2022.
18 See Ohio v. Yellen, No. 21-3787, U.S. Court of Appeals for the Sixth Circuit, filed Sept. 3, 2021; Kentucky et al. v. Yellen, No. 21-6108, U.S. Court of Appeals for the Sixth Circuit, filed Nov. 23, 2021; West Virginia et al. v. U.S. Department of Treasury, No. 22-10168, U.S. Court of Appeals for the Eleventh Circuit, filed Jan. 14, 2022; Texas et al. v. Yellen, No. 21-cv-79, U.S. Court of Appeals for the Fifth Circuit, filed June 6, 2022. For further discussion of these cases, see GT SALT Alert: Federal court blocks ARPA tax mandate enforcement; GT SALT Alert: Kentucky and Tennessee succeed in ARPA challenge; and GT SALT Alert: Ohio granted injunction from ARPA tax cut prohibition.
19 Ducey v. Yellen, No. 2:22-cv-00112, U.S. District Court for the District of Arizona, July 19, 2022 (granting Treasury’s motion to dismiss).
Jamie C. Yesnowitz
Principal, SALT Services
National Tax Office Leader
Jamie Yesnowitz, principal serving as the State and Local Tax (SALT) leader within Grant Thornton's Washington National Tax Office, is a national technical resource for Grant Thornton's SALT practice. He has 22 years of broad-based SALT consulting experience at the national and practice office levels in large public accounting firms.
Washington DC, Washington DC
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