Court: Arizona can fight rule against using COVID money for tax cuts

Arizona has a legal right to challenge a provision in the federal COVID relief package that forbids using the money for tax cuts, an appeals court ruled Thursday.

The judges of the 9th Circuit Court of Appeals rejected arguments by the Treasury Department that Congress has absolute power to set conditions on receipt of federal funds and that Arizona was free to turn away the estimated $4.9 billion it got from the American Rescue Plan Act if it disagreed.

Judge Ronald Gould, writing for the panel, said Arizona is legally entitled to claim that the conditions are “unconstitutionally vague or coercive.’’

He also said the state, by virtue of enacting a $1.9 billion tax cut in 2021, has standing to get a ruling as to whether the provision attached to the American Rescue Plan Act funds is legal. In fact, Gould said, in order to challenge the federal law, Arizona doesn’t have to say it used the COVID dollars to finance any of that tax cut.

Thursday’s ruling does not end the matter. It sends the case back to the trial judge who originally threw it out of court, and directs her to decide if the rules illegally infringe on state sovereignty.

Surplus used for tax cuts

Language in the federal law says states cannot use the money they get from the feds “to either directly or indirectly offset a reduction in the net tax revenue of each state.’’ That includes any change in state law or regulation that reduces rates or provides rebates, deductions or credits.

Any violation results in the state having to repay the government any reduction in taxes.

Arizona Attorney General Mark Brnovich argued that the language is vague, particularly the part of about indirectly offsetting tax cuts.

The issue is important for Arizona, he said, because the state’s fiscal fortunes have changed.

On one hand, during the second quarter of 2020 — as portions of the economy were closed due to the pandemic — state revenues came in well below projections. That led lawmakers to create a lower state spending plan for the following fiscal year.

But collections in two areas were greater than expected, Brnovich said.

First was a change in state law that now allows Arizona to collect sales tax from online retailers. Then there was a big increase in contracting and the taxes that go with it.

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The result was a surplus that lawmakers and Gov. Doug Ducey used for tax cuts, regardless of the COVID dollars, he said.

Beyond that, Brnovich argued that precluding legislative tax cuts to get the federal dollars puts Arizona in a no-win situation.

“States are in no position to turn down the federal government’s offer given their financial situations, which have been significantly strained by the COVID-19 pandemic,’’ he said, pointing out that Arizona’s share amounts to close to 40% of the state general fund budget.

Earlier ruling overturned

U.S. District Court Judge Diane Humetewa threw out the case.

She said Brnovich’s claim of “ambiguity’’ in the law leaving legislators uncertain of how to comply rang hollow, as it never kept them from approving the $1.9 billion tax cut package.

Gould acknowledged that Arizona has not conceded using any of the ARPA funds to finance all or part of the tax cut.

“Presumably, a $1.9 billion tax cut will lead to a reducing in Arizona’s net tax revenue,’’ he wrote. “It is hard for us to imagine how a tax cut of this magnitude would not.’’

But he said that’s not relevant to the case or the state’s ability to sue over the restriction.

Gould also said the federal government has not said it won’t try to come after Arizona if it eventually concludes the state violated the restriction on using the funds for tax cuts or other revenue reductions. That makes it a live threat, he said, which provides the state with a legal right to seek court relief.

Still, Gould suggested the state may have a problem ultimately winning its case.

He pointed out Arizona is claiming the ambiguity of the federal law, coupled with the “coercive’’ nature of offering that much money, prevents the state from being able to exercise its sovereign right to “tax its residents as it sees fit.’’ In fact, Gould said, he and his colleagues “might be somewhat skeptical’’ of that claim it is being coerced to give up its sovereign rights.

But the judge pointed out that, at this point, all they are dealing with is the question of whether Arizona has a right to challenge the restrictions, not whether they are illegal. Gould said the issue should be heard by Humetewa.