Spending Clause Conditions and the Coronavirus State Fiscal Recovery Fund

Spending Clause Conditions and the Coronavirus State Fiscal Recovery Fund

Legal Sidebari

Spending Clause Conditions and the
Coronavirus State Fiscal Recovery Fund
April 2, 2021
The American Rescue Plan Act of 2021 (ARPA) tasks the Department of the Treasury (Treasury) with
disbursing to states more than $190 billion appropriated for the Coronavirus State Fiscal Recovery Fund
(“CSFRF”). States may use CSFRF dollars to cover a wide range of costs incurred by December 31,
2024. States must certify that they will comply with statutory conditions on the use of CSFRF funds.
States that violate a condition must repay Treasury “an amount equal to the amount of funds used” in the
violation. Treasury may recover funds by reducing states’ CSFRF payments, in the event Treasury
decides to “split” payments to states, or (perhaps) through offsets applied to other federal funds owed to
states.
One condition has attracted legal controversy. ARPA prohibits states from using CSFRF funds to “directly
or indirectly offset a reduction in the net tax revenue of such State” resulting from “a change in law,
regulation, or administrative interpretation” that reduces “any tax” or delays the imposition of any tax or
tax increase. The statute lists relevant changes to include “a reduction in a rate, a rebate, a deduction, a
credit, or otherwise.” For states participating in the CSFRF program, this tax condition applies during a
“covered period” that began on March 3, 2021, and ends on the last day of the fiscal year in which a state
spends or returns all CSFRF funds or Treasury recovers improperly spent funds. States must periodically
report to Treasury “all modifications” to their “tax revenue sources.”
At least 25 States (the “States” or “objecting States”) contend that the tax condition exceeds Congress’s
authority under the U.S. Constitution’s Spending Clause. Sixteen of these States have filed suit in federal
district courts located in Alabama, Arizona, Missouri, and Ohio. Among other relief, these lawsuits ask
the federal courts to declare the tax condition unconstitutional and enjoin its enforcement. The remaining
nine States joined a March 16, 2021, letter to Treasury Secretary Janet Yellen. In general, States objecting
to the tax condition argue, in part, that the condition is impermissibly coercive and ambiguous. This
Sidebar examines both contentions and considers what might be next for the tax condition.
Spending Clause Doctrine
Arguments over the tax condition invoke key components of the constitutional design. The states are one
half of the Constitution’s “dual sovereignty” system. Under the Tenth Amendment, all “legislative power”
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not conferred on Congress by the Constitution “is reserved for the States.” The Supreme Court has
described a state’s power to “promulgate regulations of its choosing” as “central” to its role in the federal
system. Thus, Congress may not “commandeer” a state’s legislative processes by dictating “what a state
legislature may and may not do,” whether by ordering the state to enact a federal program or by
prohibiting a state from adopting certain legislation. In other words, the Constitution does not generally
confer on Congress “the power to issue direct orders to the governments of the States.”
The Constitution does confer on Congress enumerated legislative powers, including authority under the
Spending Clause to raise revenue and provide for the “general Welfare of the United States.” Subject to
various limitations, Congress may pursue its policy objectives by gifting federal funds on the condition
that the funds’ recipient, including a state, take certain actions. In this way, Congress may influence a
state’s policy choices, even by conditioning funds on a state taking certain actions that Congress could not
otherwise order a state to take. Conditions may affect a “fundamental” aspect of state sovereignty, such as
(according to federal courts of appeals) a state’s general immunity from suit. Acceptance of the federal
funds entails “an agreement to the actions.” A state that violates a valid condition has “no sovereign right
to retain funds without complying” with the condition.
There are limits on Congress’s power to condition a state’s receipt of federal funds. The Court has
described these limits as “critical to ensuring that Spending Clause legislation does not undermine the
status of the States as independent sovereigns in our federal system.” The States objecting to the CSFRF
tax condition invoke at least two of these limits: (1) the financial inducement that Congress offers states—
that is, the federal funds the state would lose if it rejected Congress’s conditions—must not be coercive;
and (2) Congress must state its conditions unambiguously.
Is the Tax Condition Coercive?
The objecting States first contend that the tax condition is impermissibly coercive. The notion that
Congress’s conditional offer of funds to states could be coercive first appeared in Spending Clause case
law in 1937. Thereafter, the Court has reaffirmed the anti-coercion rule and applied it, in South Dakota v.
Dole, to sustain a condition that put at stake a relatively small amount of federal funds (5% of specified
federal highway funds, equal to “less than half of one percent of South Dakota’s budget”) and thus gave
only “mild encouragement” for states to accept federal conditions. It was not until 2012, in National
Federation of Independent Business v. Sebelius (NFIB), that the Court used the rule to invalidate part of a
statute, namely, the Affordable Care Act (ACA).
The ACA presented states with the following choice: expand Medicaid coverage to new populations and
receive additional federal Medicaid funds, or refuse expansion and lose all Medicaid funds. Writing for a
three-Justice plurality, Chief Justice Roberts held that this choice violated the anti-coercion rule. A four-
Justice joint dissent reached the same general conclusion. The dissent reasoned that given the amount of
federal funds at stake and the “heavy” federal taxes levied to support the program, as a practical matter
states could not “refuse to participate in the federal program” and then “substitute a state alternative.”
Lower courts have applied the plurality’s reasoning because it rests on narrower grounds than the dissent.
Similarly, the objecting States appear to invoke the NFIB plurality.
The NFIB plurality stressed the amount of funds that a state would lose if it rejected Congress’s condition
(“over 10 percent of a State’s overall budget”). The plurality also appeared to place weight on the fact that
Congress’s condition threatened both new federal funds and existing federal funds for what the plurality
determined was a different program and did not govern use of those funds. Conditions on the use of
federal funds are upheld, the plurality reasoned, because those conditions are “the means by which
Congress ensures that the funds are spent according to its view of the General Welfare.” Conditions that
do not “govern the use of the funds” cannot be justified on that basis. When Congress threatens “to
terminate other significant independent grants,” the conditions “are properly viewed as a means of

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pressuring the States to accept policy changes” through use of a penalty. If Congress’s conditions are
coercive, a state cannot be said to have voluntarily agreed to the condition by accepting the federal funds.
How a court might resolve the objecting States’ coercion argument is unclear. The NFIB plurality stressed
the magnitude of funds affected by the Medicaid expansion provision. Some states could forgo a large
amount of federal funds by rejecting the tax condition. While Treasury has not yet released state
allocations, the allocations will likely be significant for many objecting States. For example, Arizona
expects to receive about $4.7 billion from the CSFRF, a figure equal to approximately 40% of its annual
general fund budget. The pandemic has caused state revenues to decline and demand for state services to
increase. The objecting States therefore contend that no state “can turn down” ARPA’s “financial
inducement.”
The NFIB plurality also stressed the nature of the condition and the funds at stake: a condition on receipt
of new as well as existing federal funds that did govern the use of those funds. Given this relationship
between the condition and threatened funds, the NFIB plurality agreed with states that the choice they
faced under the ACA “serve[d] no purpose other than to force unwilling States” to accede to the
expansion condition. The States stand to lose only CSFRF funds by rejecting the tax condition, and the
condition governs the use of those funds. By crafting a condition governing the use of only new funds, a
court might conclude that Congress had a purpose beyond threatening states to accept the tax condition.
For example, if the goals of a conditional spending program include supplementing state spending in
particular areas, that goal can be undermined by fiscal substitution, the practice of using federal funds to
replace state dollars for a given program. In narrower grant programs, Congress might include, as part of
the bargain presented to states, a condition that requires states to use federal funds to supplement and not
supplant spending from nonfederal sources.
Is the Tax Condition Ambiguous?
The objecting States also contend that the tax condition is impermissibly ambiguous. The Supreme Court
has likened Spending Clause legislation to a contract whose legitimacy depends on states knowingly and
voluntarily accepting Congress’s conditions. There can be no “knowing acceptance if a State is unaware
of the conditions or is unable to ascertain what is expected of it.” Thus, Congress must speak with a “clear
voice” when imposing conditions on federal funds offered to states. Here, the objecting States contend
that the tax condition lacks the requisite clarity.
In perhaps the leading case on this clear-statement rule, the Court held in Pennhurst State School and
Hospital v. Halderman that a “bill of rights” provision in a federal grant statute merely expressed
“congressional preference” for certain types of treatment for the developmentally disabled (i.e.,
“appropriate treatment” in the “least restrictive” environment that would maximize “developmental
potential”). The bill of rights provision did not require, as a condition of the federal grant, that states
actually fund such treatment. In deciding no such obligation existed, the Court cautioned that the judicial
task is not to ask “whether a State would knowingly undertake” the alleged obligation. Rather, the crucial
inquiry is “whether Congress spoke so clearly that we can fairly say that the State could make an
informed choice,” considering the requirements in effect when the grant was made.
Pennhurst vindicated a state’s claim that particular statutory language was only precatory and imposed no
condition on federal funds whatsoever. Courts have also considered ambiguity contentions when a state
could not deny the general existence of a condition but instead argued that the condition was not
sufficiently defined to inform the state how it might apply in particular cases. Four years after Pennhurst,
in Bennett v. Kentucky Department of Education, the Court held that Kentucky had sufficient notice of a
condition requiring use of federal education funds to supplement and not supplant nonfederal education
spending. The Court explained that the existence of the condition was clear and that Pennhurst did “not
suggest that the Federal Government may recover misused federal funds only if every improper

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expenditure has been specifically identified and proscribed in advance.” The application of a condition on
the use of funds may be clear in one context but unclear in another.
Here, the States objecting to the CSFRF condition appear to concede that it would impose some limitation
on their use of CSFRF funds in connection with changes to state tax law. In other words, the States do not
argue, as was the case in Pennhurst, that the tax condition is precatory only. The States argue instead that
the tax condition is ambiguous because its application to particular state tax reductions is unclear. The
States contend that the tax condition could be read merely to prohibit states from expressly earmarking
CSFRF funds as offsets to the revenue decline associated with a particular state tax reduction. The States
also contend that the condition might prohibit them from undertaking any tax reduction. ARPA prohibits
states from “indirectly” offsetting such measures with CSFRF funds. Money is also fungible, meaning
that each CSFRF dollar is interchangeable with a dollar received on account of state tax laws. On this
view, by receiving CSFRF funds and then reducing a state tax, a state could have “indirectly” violated the
tax condition, even if the change had no connection to the availability of CSFRF funds or the state’s
pandemic response. Certain States contend that an unintentional reduction in net tax revenue may violate
the tax condition.
It is unclear how the States’ Pennhurst arguments might fare. The Supreme Court last expressly applied
Pennhurst in 2006, when, in Arlington Central School District Board of Education v. Murphy, it
considered a statute authorizing courts to award “reasonable attorneys’ fees as part of the costs” to parents
who prevail in an action under the Individuals with Disabilities Education Act. The Court held that the
statute lacked clear notice that a state would be liable for a prevailing parent’s expert fees. The Court
explained that a statute must provide “clear notice regarding the liability at issue” in a particular case
when the state decided to accept the federal funds, perhaps pointing to a more demanding application of
the clear-notice rule than in earlier cases. Murphy involved the liabilities that a state might owe to private
parties based on the obligations the state assumed by accepting federal funds. Murphy did not consider
how particularly a grant statute must define allowed costs. Bennett cautions that in complex conditional
spending programs, a category that undoubtedly includes the CSFRF program, “the Federal Government
simply could not prospectively resolve every possible ambiguity concerning particular applications of the
requirements” of the grant statute. The Court has variously described Pennhurst’s ambiguity test,
providing both the objecting States and the federal government room to argue that the tax condition fails
or passes that test.
What Is Next For The Tax Condition?
ARPA directs Treasury to begin distributing CSFRF funds to states, to the extent practicable, not later
than 60 days after a state certifies that it will comply with the conditions placed on those funds. The Act
also grants Treasury authority “to issue such regulations as may be necessary or appropriate” to carry out
the CSFRF program. On March 23, 2021, Treasury previewed for the objecting States forthcoming
“guidance” on the CSFRF program. According to Treasury, nothing in ARPA prevents states from
“enacting a broad variety of tax cuts,” so long as CSFRF funds are not used to offset a reduction in state
tax revenues on account of those measures. Thus, states may modify state tax laws so long as they replace
“the lost revenue through other means.” While the import of this statement is not clear, it suggests that
Treasury reads the tax condition as requiring states to pair state tax reductions with offsetting tax
increases. Treasury says that its guidance will be available before states must decide whether to certify
future compliance with the tax condition. Though Treasury’s guidance likely will not affect the objecting
States’ coercion arguments, the guidance could factor in the States’ ambiguity arguments. Supreme Court
case law suggests that “regulations” and “other guidelines” can help clarify statutory conditions, though
certain States may contest that proposition.

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As noted above, to date sixteen States have filed suit challenging the tax condition. Other States might file
challenges of their own or participate in a pending suit. Ohio has requested a preliminary injunction
barring the federal government from enforcing the tax condition pending the outcome of Ohio’s lawsuit.
The federal government has not yet substantively responded in any of the pending suits. The Ohio district
court is scheduled to hear oral argument on Ohio’s preliminary injunction request on April 30, 2021.
Hearings have not yet been scheduled in the other cases.

Author Information

Sean M. Stiff

Legislative Attorney

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