Finance officials offer cover on clawback of federal funds related to special session tax cuts

A day after a Talk Business & Politics report that state finance officials told lawmakers the state could be facing an $800 million clawback provision of federal funds, a new memo seeks to negate that possibility.

Federal officials have outlined guidelines to recoup money sent to the states during the COVID-19 pandemic if those funds were used for tax cut purposes. With Gov. Asa Hutchinson planning an early August special session to accelerate tax cuts, lawmakers have been pressing for more information.

Originally and according to TB&P sources, the Department of Finance and Administration has suggested for months the potential recoupment, or clawback, could be less than $100 million. With a $1.6 billion surplus, the governor and legislators are looking to expedite $500 million in tax cuts by speeding up a reduction in the top tax rate from 5.5% to 4.9%.

Earlier this week, legislative leaders were told that the feds’ clawback could be as high as $800 million, which was cause for alarm. Now, a memo dated Tuesday (July 26) says the chances for federal recoupment is “extremely low” and “severely limited.” No exact dollar figure is provided in the memo.

Robert Brech, State Budget Officer, states in his memo to Gov. Asa Hutchinson and DFA Secretary Larry Walther that he believes Arkansas is on solid ground to enact tax cuts without penalty from the feds.

From the memo:

“As part of the process leading up to the special session, there have been grave concerns regarding the potential for recoupment under the American Rescue Plan Act (“ARPA”). ARPA does contain provisions relating to the recoupment of funds should they be used improperly.

“It is clear that funds are not to be used to offset a reduction in the net tax revenue of a state following tax cuts implemented by the Arkansas General Assembly. However, it is not required nor planned for this to occur. Arkansas’s budget grew during the recent fiscal session at a normal percentage, while revenues continue to surpass budgetary needs. It is the reduction of excess revenues that will be used to pay for the tax decreases. Absolutely no ARPA funds will be used to directly offset the potential tax cuts. Any indirect offset would be difficult to compute, if it exists.

“Even if there was a finding that Arkansas indirectly utilized ARPA funding to offset tax reductions, the potential liability would be severely limited. The Department of Finance and Administration has been making the calculation necessary to determine if the safe harbor provisions would be applicable. Those calculations are based on 2019 state tax collections adjusted for inflation. It is a real possibility that Arkansas will fail the initial test after tax cuts have been implemented; however, it will not fail the test of using funds in violation of ARPA. In the event it should, the potential liability will be diminished greatly and not what was previously estimated.”

The memo quotes U.S. Secretary of Treasury Janet Yellen, who said:

“Nothing in the Act prevents States from enacting a broad variety of tax cuts. That is, the Act does not ‘deny States the ability to cut taxes in any manner whatsoever.’ It simply provides that funding received under the Act may not be used to offset a reduction in net tax revenue. If states lower certain taxes but do not use funds under the Act to offset those cuts – for example, by replacing the lost revenue through other means – the [Tax Mandate] is not implicated.”

Arkansas is involved in litigation in this matter. The state joined a federal court case in Alabama where the state prevailed in its ability to keep the federal funds and avoid a recoupment. That ruling is on appeal. Brech’s memo singles out this case and indicates that attorneys for Arkansas believe their legal footing is sound.

“The Attorney General’s Office has indicated the potential for any recoupment is extremely low,” he writes.

You can read the full memo here.

Some legislators are still nervous about the tenable position.

One idea being explored by state lawmakers to safeguard against a potential liability, if the federal government succeeds in its appeal, is to freeze about $800 million in CARES Act funding that has yet to be dispersed. That could delay projects including broadband expansion, water grants and criminal justice reforms.