State Policy Network
Five ways state and local governments can put the latest COVID-19 stimulus package to good use

The latest COVID-19 stimulus package, the American Rescue Plan Act (ARPA), allocated $350 billion to state and local governments, and laid out an imprecise framework of constraints on how this mountain of federal cash can be used. Another $175 billion was allocated for education, with the majority going to K-12. State and local government officials will soon face an unprecedented task of determining how to spend these funds in ways that won’t undermine the long-term financial health of their communities or add to taxpayers’ burdens in the future.

Do states need this federal stimulus?

The $350 billion in federal cash is largely, if not entirely, unnecessary to backfill state and local fiscal gaps. A stronger-than-expected economic recovery has resulted in state and local budgets performing better than anticipated. According to a State Policy Network analysis, state and local governments entered the pandemic with a $200 billion cushion of rainy-day funds and other unreserved balances. On top of these funds, the federal government provided $400 billion in aid to state and local governments. The pandemic recession caused aggregate state and local revenues to come in roughly flat year-over-year, which was $140 billion short of the revenue growth governments were expecting since the pandemic began. In short, state and local governments already had more than enough resources to cover any fiscal gap before the ARPA was enacted.

How states can and cannot spend the latest COVID-19 stimulus

Subtitle M of the American Rescue Plan Act lays out the logistics for allocation of the federal funds:

$350 billion will go to state and local governments, with $219.8 billion distributed to states, territories, and tribal governments (as described in Section 602). Local governments will receive $130.2 billion (Section 603).

In general, the money is to be used for:

The law notably prohibits state governments from using the federal funds to cut taxes, with the following operative language:

A State or territory shall not use the funds provided under this section or transferred pursuant to section 603(c)(4) 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.

The law also prohibits states from using the funds for a deposit into any pension fund. Local governments are similarly prohibited from using the money for deposit into pension funds. Significantly, though, local governments are not prohibited from using the funds for reducing taxes.

Recommendations for state and local use of excess federal funding

Although the excess funds will undermine fiscal federalism, state policymakers and state think tanks should leverage our system of federalism to share ideas on the best use of funds across the states.

The Buckeye Institute has started the conversation with first principles for using the federal money. These principles include guardrails and transparency requirements to preclude any spending cliffs or misuse of funds:

Tax Foundation has considered the prohibition on using federal dollars for tax reductions and laid out five scenarios for tax relief. Some of the scenarios are clearly permissible, others are not, and yet others are unclear without additional Treasury Department guidance. Policymakers should consider these scenarios as they adjust their tax and spending structures.

Aside from those ideas explicitly laid out in the bill, an array of other policy ideas are worth considering, such as addressing taxes and unemployment compensation, healthcare benefit reform, education choice reforms, and one-time spending on items like debt or infrastructure.

Unemployment Insurance

Unemployment trust funds are depleted across the country. Ideally, Treasury guidance will explicitly allow the use of federal dollars to backfill these depleted trust funds. The depleted funds are scheduled to trigger employer payroll tax hikes, thus increasing payroll taxes on businesses right when local economies need businesses to aggressively bring back jobs.

If the trust funds cannot be directly replenished, then states should consider paying out ongoing claims with federal funds so that state unemployment tax revenues can be exclusively directed to replenishing the state’s trust fund. Furthermore, states might be able to use federal funds to replace lost state unemployment tax funds to the extent their unemployment tax revenues were lower in FY 2020 or 2021 than they were in FY 2019. Like many ideas considered below, it is unclear whether these uses of federal funds are in line with the law’s allowance for addressing negative economic impacts of the public health emergency.

Deductions and expensing

Federal funds cannot be used to directly reduce taxes, but they might be used as a bridge to change the timing of when taxes are due in a way that favors economic growth. For example, businesses amortize operating losses and investment costs over years. However, federal dollars might be leveraged to permanently provide full and immediate expensing for new business investments and to provide more rapid deductions for any operating losses. These changes wouldn’t reduce a state’s tax revenue in terms of dollars collected, but it would change when the dollars are collected. Once again, it is unclear whether these uses of federal funds are in line with the law’s allowance for addressing negative economic impacts of the public health emergency.

Local Taxes

The new law notably does not restrict local governments from using the funds for tax reductions. Locals might reduce property taxes voluntarily. Alternatively, state policymakers might assess that local governments are flush in cash and pass a law requiring local governments to put a significant portion of the federal funds toward tax relief unless the local governments can certify a certain degree of revenue failure.

In addition, 43 states include business tangible personal property (TPP) taxes in their property tax base. TPP should be excluded from the property tax base, yet it is difficult for the state to remove TPP because locals rely on it for tax revenue. Excess federal funds may create an opportunity for states to exempt a larger portion of TPP from the tax base by increasing the value of business TPP that is exempt from taxation. Once again, it is unclear whether this state-initiated local tax reform is a qualifying form of economic relief.

Education

The Buckeye Institute compiled additional and comprehensive ideas tailored to Ohio’s situation, some of which will apply in other states. Recommendations include education savings accounts (ESAs) to address the persistent education challenges families faced due to school closures. ESAs would give families money to put toward education options of their choice and protect them from the scenario of ever missing another year of school.

Healthcare

Reason Foundation points to the option of pre-funding government employee retirement health plans and transitioning them to health savings accounts. This solution would increase the likelihood of retirees having reliable healthcare coverage when they need it, and it would give them control and portability over their healthcare dollars.

State leaders should explore additional spending options now

Policymakers will undoubtedly develop more ideas on how states can use funds, such as reducing debts and addressing one-time infrastructure needs. As new recommendations come from the states, SPN will update this page to share ideas across state lines.   

Treasury guidance should further clarify what is and is not allowed. If states feel they are unconstitutionally restricted on how they can use the money, they may sue the federal government for relief. In the meantime, state and local elected officials face an unprecedented responsibility for finding productive—or at least less destructive—uses of the unnecessary federal funds and unclear allowances for how the funds can be used. State think tanks can be valuable resources for recommendations that empower lawmakers to make financially sound decisions and give families and citizens opportunities to thrive.

Additional Resources

State COVID Relief Guide
State Policy Network

The States Don’t Need a Biden Bailout
State Policy Network, National Review

Sound Spending Principles to Guide Ohio Policymakers
The Buckeye Institute

Does the American Rescue Plan Ban State Tax Cuts?
Tax Foundation


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Categories: News
Organization: State Policy Network