Balkinization: What is a Tax Cut, Anyway?

What is a Tax Cut, Anyway?

Joseph Fishkin

I’m not going to write a whole blog post today about the meritless (from the point of view of precedent and doctrine) yet also highly dangerous (because conservative constitutional politics may turn out to be way more important than current precedent and doctrine) states-rights legal challenge to the American Recovery Plan Act. Lawyers apply the ordinary tools of legal analysis to a lawsuits of this sort at their peril. Read David Super’s great post below for more about the precedents. If the current conservative supermajority in the Supreme Court decides to create a new principle that “if Congress offers states lots of money, it can’t attach too many strings,” then they’ll do that, using nicer words. I want to write instead about an issue deep in the weeds of the controversy, one that I’ve always found interesting and that this suit puts a fine point on. I am not a tax lawyer, just an interested outsider to this field, and I welcome input from those who know more.

The aid to state and local governments in ARPA is there to provide badly needed funds for various pandemic-related purposes and also to cover the overall state budget shortfalls that some states face as a result of the pandemic. (These are highly uneven: some state budgets like Alaska’s are in total free fall, while many other states’ revenues are holding up fine. Localities are mostly in worse shape than states but this lawsuit is about the $200 billion or so that goes to states.) The Act says states can’t take the money and then turn around and use it, “directly or indirectly,” to offset a tax cut. Opponents are now claiming that restriction is illegal, with various off-the-wall-until-maybe-now-who-knows arguments about the 10th Amendment and so on. What the Act actually says, since “tax cut” is more of a political phrase than a legal one, is that if you (a state) take this money, you can’t use it offset a “reduction in the net tax revenue . . . resulting from a change in law” or regulation; the statute gives some examples: “a reduction in rate, a rebate, a deduction, a credit,” or delaying some tax increase that would have gone into effect. Basically, the drafters tried to think of different ways to frame or package a tax cut, and are saying, you can’t use the money for that. Seems straightforward enough.

But this is actually a very odd line to draw. From many perspectives—including most rational ways of thinking about a state’s budget, and also the tools of standard economic analysis—tax policy and spending policy are highly fungible. Anything you can do with one you can do with the other. You can pay people $X to do something (expenditure) or you can give them a tax credit of $X if they do the same thing (taxation).

So in this case, suppose a state has some money. Its leaders believe the best use of that money is to give it back to the people. It could do that with a tax cut, or it could do that with a spending program that consists of writing everyone checks. According to conventional definitions of these words, the tax cut approach reduces “net tax revenue,” whereas the spending program, almost by definition, doesn’t. Of course there are plenty of ways to fuzz this up. You can make a tax cut look and feel more like a spending program if you make it refundable, so that people can literally get checks regardless of taxes paid; those checks look a heck of a lot like a government expenditure. Similarly you can make a spending program look and feel like a tax cut if you style the checks as “rebates”—and especially if you make eligibility and/or amount contingent on prior taxes paid in some manner. It seems from the statutory language quoted above that doing that last thing with ARPA funds might actually turn your expenditure into a tax cut for ARPA purposes and land you in hot water under the law. So… best to avoid writing “rebate” on the checks, I guess? But I mean, come on. The entire phrase “tax expenditure” exists to describe the budgetary and economic equivalence here: when you cut taxes in a targeted way, this is well described as a form of government expenditure.

And yet. Just because two things might be equivalent in budgetary terms, or even in economic terms, doesn’t make them equivalent in all respects. In political terms, many politicians find it highly salient whether a fiscal policy is styled as an expenditure or a tax cut.

This is in part Grover Norquistism. In the world according to Grover, tax cuts are good, tax hikes are bad, and spending is honestly not quite as important. This distinction is ridiculous in its formalism. But a politician living in fear of Grover would be well advised to style any proposed expenditure as a tax expenditure, which can in turn be framed as a tax cut. Even better, once the program is in place, any future repeal of said program can be framed as a tax hike. ARPA’s amazing child tax credit expansion is a great example of this. Any politician who votes to allow it to expire in the future will be voting for a HUGE tax hike, and I hope Norquist and his people will make sure that tax hike is verboten. Tax expenditures often seem to linger on the books for years, long after an equivalent spending program would have been axed in the give and take of budgetary politics. Tax expenditures affect the budget but they are somehow magically “off budget”! This is part of why so many good government folks rightly hate them—and so many actual government folks love them.

So this brings me to the mystery at the heart of this lawsuit. The contested provision of ARPA prohibits the use of ARPA funds to offset tax cuts (including rebates, etc.). But there are plenty of ways a state can send its citizens money that do not run afoul of this provision. ARPA itself says that the ARPA funds are supposed be used to send “assistance to households.”

It is not very hard to figure out what a state should do if instead of paying state employees or essential workers or doing any of the other things the statute mentions, the state simply wants to send state residents some checks—either with ARPA funds themselves or with other funds where ARPA funds offset that spending. Go ahead and send the checks! They are “assistance to households.” So therefore, what the heck? Why does this lawsuit exist?

I see two possibilities, neither particularly good:

1. Spending money on “assistance to households” or some similar thing isn’t what these states want to do. They want to cut taxes. Why? Perhaps (A) they want to keep them cut, long-term, because once cut, taxes are hard to raise in conservative states; much better that than an equivalent spending program. Or alternatively, perhaps (B) they don’t want the money to go to all the households equally or anything remotely resembling that: they want to reward their friends with more targeted tax cuts (e.g. cut income tax rates to benefit high-income individuals, or something more specific still) and they cannot justify or politically could not pass the same distributive pattern as a spending program. So it has to be a tax cut.

2. They don’t care about any of this. Those attacking the ARPA are looking for a novel way to get a court to strike a blow against an unbelievably popular piece of legislation that they and their donors oppose. The objective has much more to do with who is in the White House and who voted for this bill than it does with any of the substance of the controversy, and if scoring a political hit requires mangling centuries of actually fairly important precedent about the reach of the federal spending power, then from their perspective that’s at least acceptable, and perhaps awesome.

Posted 3:21 PM by Joseph Fishkin [link]