Yellen: ‘Thorny questions’ for Treasury over limiting state tax breaks

The matter of how the Biden administration will restrict states from using corporate tax breaks if they receive federal COVID-relief aid will mean “thorny questions” for the federal government as it hashes out the regulations implementing the law, Treasury Secretary Janet Yellen told lawmakers on Capitol Hill on March 24.

New Jersey is slated to get $6 billion of direct federal aid, to cover expenses related to the pandemic and make up for revenue losses. But its ambitious $14.5 billion economic recovery plan – signed in January – could hit a bureaucratic snag because of the new rules.

“We will have to define what it means to use money from this act as an offset for tax cuts. And given the fungibility of money, it’s a hard question to answer, but that’s what we’re required to do, and we will — we will do our best to offer guidance on it,” Yellen told the U.S. Senate Banking Committee, adding that her department will need to grapple with a “host of thorny questions” in the rulemaking process.

Republicans have widely slammed the measure – a single paragraph in the 600-page, $1.9 trillion American Rescue Plan. Ohio, a Republican state, is suing the Biden administration over the language, and the attorneys general for 21 red states are threatening legal action against Yellen over the text.

West Virginia Attorney General Patrick Morrisey tweeted on March 23 that the state was “now getting ready for court,” and said that the Biden team’s response to their requests for clarification on the language was “unacceptable.”

“It seems like the states are hamstrung and cannot do anything until you give them guidance,” Sen. Mike Crapo, an Idaho Republican, told Yellen.

The package includes $350 billion in state and local aid, but a provision in the law limits how states can use corporate tax breaks to attract businesses, prohibiting states from using federal aid to provide tax cuts.

Under the ARP, states “shall not use funds … to either directly or indirectly offset a reduction in the net tax revenue … 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.”

Economists, business advocates and New Jersey officials have different assessments on whether this provision would limit the ability of the state to use these new tax breaks to lure businesses.

One assessment is that the law, known as the New Jersey Economic Recovery Act of 2020, will be grandfathered in because it was signed before the ARP was enacted in March.

But the federal language could potentially block regulations the New Jersey Economic Development Authority implements from here on out, as well as any future tax break awards – both of which would happen after the ARP’s March effective date.

The issue is how to determine whether the state is using federal dollars for tax breaks, Yellen said.

The vagueness of ‘indirect’ potentially ties state’s hands for three years on setting their own policy,” said Jared Walcak, a state analyst with the Tax Foundation, a Washington D.C. think tank.

“[W]hat if states take advantage of that relief and then cut taxes,” he added in a March 10 blog post. “If this facilitates the tax cut, it is likely prohibited.”

A one-time $100 million tax cut made possible through $100 million in federal aid would be prohibited, he suggested. But a tax cut for that same amount made possible through outside factors – booming businesses or sound budget practices – would likely be allowed under the law.