Judge rules Iowa can use federal pandemic aid to cut state taxes

MONTGOMERY, Ala. — A federal judge has blocked the U.S. Treasury from enforcing a provision of the American Rescue Plan Act that prohibited states from using the pandemic relief funds to offset new tax cuts.

U.S. District Judge L. Scott Coogler ruled Monday in Alabama that Congress exceeded its power in putting the tax mandate on states. He entered a final judgment in favor of 13 states including Iowa that had filed a lawsuit and instructed the Treasury Department not to enforce the provision. The judge left the rest of the law in place.

The American Rescue Plan steered $195 billion in flexible relief funds to states, but specified they could not use the federal relief dollars to offset the revenue reduction caused by tax cuts.

The judge described the tax-cut restrictions as "a federal invasion of State sovereignty" that was "unconstitutionally ambiguous," leaving states guessing as to whether their tax cuts would trigger a repayment of federal funds.

"The Tax Mandate's restriction on direct or indirect state tax cuts pressures States into adopting a particular and federally preferred tax policy," Coogler wrote. That "may disincentive" states "from considering any tax reductions for fear of forfeiting ARPA funds,"

The lawsuit was filed by Alabama, Arkansas, Alaska, Florida, Iowa, Kansas, Montana, New Hampshire, Oklahoma, South Carolina, South Dakota, Utah and West Virginia.

“This is a major victory for the State of Iowa and Iowa taxpayers,” Republican Gov. Kim Reynolds said in a statement. “The Biden Administration was trying to punish fiscally responsible states like Iowa, which has a record budget surplus, and that’s why we took legal action. With this ruling, Biden’s Administration can’t keep us from cutting taxes and I look forward to doing just that.”

Justice Department lawyers representing the Treasury Department argued the money should be used for its intended purpose — pandemic recovery.

"Congress did not provide Rescue Plan funds for States to replace purposeful decreases in net tax revenue; it provided the money to help States economically recover from the pandemic in ways they otherwise could not," federal lawyers wrote in an August filing.

Federal government lawyers added, "states are free to cut all the taxes they want, as long as they do not use the federal aid to `offset' any decreased revenue."

Reynolds announced in September that Iowa ended fiscal 2021 with a general fund surplus of nearly $1.24 billion — in addition to about $1 billion in cash reserves and emergency funds.

Legislative Democrats contend the Reynolds administration has shorted K-12 education, regent universities, water quality improvements and other needs to stockpile money for tax cuts.