Federal money won’t offset tax cut, state budget chief says; recovery provision in law worries Arkansas officials

Arkansas budget director Robert Brech (left) answers questions during a meeting of the Joint Budget Committee meeting at the state Capitol in Little Rock in this Jan. 11, 2022 file photo. (Arkansas Democrat-Gazette/Thomas Metthe)
Arkansas budget director Robert Brech (left) answers questions during a meeting of the Joint Budget Committee meeting at the state Capitol in Little Rock in this Jan. 11, 2022 file photo. (Arkansas Democrat-Gazette/Thomas Metthe)

No federal American Rescue Plan funds will be used to directly offset the potential tax cuts that lawmakers will consider in the special session planned to begin Aug. 9, and any indirect offset would be difficult to compute, if it exists, state budget director Robert Brech said.

“Should funds be used in violation of [the American Rescue Plan Act], there is a recoupment provision that could be applicable,” Brech said in a memo dated Tuesday to Gov. Asa Hutchinson and Department of Finance and Administration Secretary Larry Walther and released Wednesday.

But even if there was a finding that Arkansas indirectly used federal American Rescue Plan funding to offset tax reductions, “the potential liability would be severely limited,” Brech said.

In March 2021, President Joe Biden signed the $1.9 trillion American Rescue Plan into law as part of an effort to help the U.S. recover from the economic and health effects of the covid-19 pandemic.

Brech said there have been “grave concerns” about the potential for recoupment under the American Rescue Plan Act as part of the process leading up to the special session.

Walther said Wednesday that finance department officials initially estimated the potential liability for American Rescue Plan funds at about $92.8 millionin May based on tax cuts enacted in the December special session. They later increased their estimate of the potential liability to about $450 million, and then to about $853 million with the tax cuts planned for the special session starting Aug. 9 and rising inflation before “we just took a fresh look,” he said.

Brech said the finance department has been making the calculations necessary to determine if the “safe harbor provisions” would be applicable, and 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 the tax cuts have been implemented,” he wrote in his memo. “[H]owever, it will not fail the test of using the funds in violation of ARPA. In the event it should, the potential liability will be diminished greatly and not what was previously estimated.” Arkansas has joined 12 other states seeking to invalidate and enjoin the “Tax Mandate” of the American Rescue Plan Act in a case filed in March of 2021 in federal court in Alabama, Brech said. The act allocated $195 billion in flexible relief funds to states, but the wording from Congress specifies that states cannot use that money to offset new tax cuts.

In November, a federal judge permanently enjoined the U.S. treasury secretary from enforcing the tax mandate against Arkansas and the 12 other states, describing the tax cut restriction as “a federal invasion of state sovereignty” that was “unconstitutionally ambiguous.” The judge’s ruling has been appealed to the 11th U.S. Circuit Court of Appeals, Brech said.

Republican Attorney General Leslie Rutledge’s office has indicated the potential for any recoupment is extremely low, he said.

“Given Arkansas’s current economic condition, record surpluses the previous two fiscal years, and forecasted surpluses next year with or without further tax reductions, the Tax Mandate should not be a factor in moving forward with the proposed tax changes,” he wrote in his memo.

Senate President Pro Tempore Jimmy Hickey, R-Texarkana, said Wednesday in an interview that the finance department’s changing its estimate of the state’s potential liability to the federal government for federal American Rescue Plan funds this week “is very aggravating, to say the least.” “It doesn’t matter what they are saying at this point,” he said.

Asked if his administration made a mistake in its calculations and who is to blame, Hutchinson said Wednesday there is no one to blame.

“The key is getting the right information and making the right decision,” the Republican governor said in a written statement. “There had been no final determination on the issue, and for that reason all the prep material was marked for discussion only. It was my view all along that the federal government cannot dictate state tax policy, and the court decision and the [state Department of Finance and Administration] analysis confirms that position.” Hickey said he favors proceeding with the tax cuts planned for the special session, but he believes the state should not spend about $800 million in federal American Rescue Plan funds until there is a final court ruling to determine the state’s potential liability to the federal government.

However, Hutchinson said “in the final analysis there is no real risk on spending the ARPA [American Rescue Plan Act] funds and I support proceeding with the critical investments for broadband expansion, workforce training and other needs.” House Speaker Matthew Shepherd, R-El Dorado, said Wednesday in an interview that the finance department’s latest estimate on the potential liability to the federal government “is more in line with what’s been shared in the past” and department officials have a high level of confidence in that estimate.

“I am comfortable with moving forward with the tax cuts,” he said.

But Senate Democratic leader Keith Ingram of West Memphis said Wednesday in an interview that “I get the sense that the tax cut is blinding people to the larger picture.” He said the special session should be devoted to education and providing pay raises for teachers and support personnel and funding for school safety grants.

Ingram said tax cuts shouldn’t be put on the call for the special session if there is any chance of the state being liable to the federal government for federal American Rescue Plan funds.

Earlier this month, Hutchin - son said he wouldn’t put a teacher salary increase on the agenda for the special session because of the lack of support in the Republican-dominated Legislature for a teacher pay increase in the session.

The governor initially proposed raising teacher salaries to a minimum of $46,000 and implementing at least a $4,000 salary increase. He subsequently trimmed his proposal to increase the minimum teacher salary to $42,000 a year and to provide a $4,000 increase to every teacher for the 2022-2023 school year at a projected cost of $150 million of the state’s $1.6 billion surplus. Under Act 170 of 2019, the minimum teacher salary was $34,900 for the 2021-2022 school year and will increase to $36,000 in the 2022-2023 school year.

Department of Education Secretary Johnny Key has pointed out that going into the 2022-2023 school year, base salaries in Oklahoma, Missouri, Tennessee and Mississippi are all higher than Arkansas, and that Mississippi just increased its base salary to $41,500 along with an approximately $5,000 salary increase for every teacher.

House and Senate Democrats have signaled they support raising teacher salaries in the special session, and some Republicans have said they support considering teacher raises in the special session.

On Tuesday, Hutchinson told about 125 people attending a luncheon meeting of the Rotary Club 99 of Little Rock that “I want to applaud the General Assembly for recognizing the need to do more for teachers.

“I think we have moved the ball forward,” the governor said. “I’ve advocated for teacher salary increases, and while we will not be able to get it done for this year, hopefully the bonuses that they’ve approved will be helpful.” Hutchinson spokeswoman Shealyn Sowers said Wednesday that the governor was referring to his administration’s record on pushing for teacher pay raises.

Last week, the Legislative Council rescinded its approval last month of $500 million in spending authority for the state Department of Education to disperse funds under the federal American Rescue Plan’s Elementary and Secondary Schools Emergency Relief Fund, and then granted back $42 million of that spending authority.

The council recommended the funds be used to give a $5,000 bonus to full-time teachers and a $2,500 bonus to full-time staff. The state Department of Education will be required to request the council’s approval for school districts’ plans to use these federal funds.

As far as the bonuses, Hutchinson told the Rotary Club 99 on Tuesday that “I think it is going to be varying amounts and a little bit inconsistent out there.

“But it shows the support that is there for our teachers and sets the stage [for] next January [for] the next administration, [and] hopefully the Legislature will really kick that into gear even more,” he said.

Regard - ing tax cuts, Hutchison said the state has been able to cut its top individual income tax rate from 7% when he became governor in 2015 to 5.5%, and that rate is slated to be reduced to 4.9% in the next few years under state law enacted in the December special session.

He said he hopes there will be a special session starting Aug. 9 in which the Legislature will accelerate the implementation of the state’s top individual income tax rate to 4.9% more quickly, and set aside $50 million for a school safety grant program.

“Those tax cuts have come at a time when we wanted to be competitive with our surrounding states … so we lowered that rate consistently and carefully,” Hutchinson said. Two of Arkansas’ neighboring states — Tennessee and Texas — don’t have state income taxes.

The tax cuts have put more money into people’s pockets to spend and helped grow the state’s economy, he said.

Unlike Kansas and Oklahoma, Arkansas hasn’t cut taxes too quickly and sharply, so it couldn’t provide services, Hutchinson said. Arkansas has increased support for the public schools, colleges and universities. workforce education, foster children and expanded health care coverage, he said.

Even with those investments, state government has increased its savings account during his administration from zero to $1.2 billion in its catastrophic reserve fund — or 20% of the state’s general revenue budget — in case of a future economic downturn or slowdown, the governor said Tuesday.

The four-pronged tax cut package that Hutchinson and Republican legislative leaders have agreed upon for the special session includes: Accelerating the implementation of cutting the state’s top individual income tax rate from 5.5% to 4.9%, retroactive to Jan. 1, 2022. The state’s top individual income tax rate is scheduled to be cut to 5.3% on Jan. 1, 2023, to 5.1% on Jan. 1, 2024, and to 4.9% on Jan. 1, 2025, under current state law.

Accelerating the reduction in the state’s top corporate income tax rate to 5.3% on Jan. 1, 2023. Arkansas’ top corporate income tax rate of 6.2% dropped to 5.9% on Jan. 1, 2022. The rate is scheduled to drop to 5.7% on Jan. 1, 2023, to 5.5% on Jan. 1, 2024, and to 5.3% on Jan. 1, 2025, under current state law.

Adopting the 2022 federal Section 179 depreciation schedule as it existed on Jan. 1, 2022, which provides an income tax reduction for the expensing of certain property.

A temporary nonrefundable income tax credit in tax year 2022 of $150 for individual taxpayers with net income up to $87,000 and of $300 for married taxpayers filing jointly with net income up to $174,000.

This proposal is projected by the finance department to reduce state general revenues by $156.3 million in fiscal 2023. This proposal is designed to replace a previous one to reduce the income tax bracket on income ranges from $5,100 to $10,299 from a 2% tax rate to 0% for those with net income of less than or equal to $87,000 for tax year 2022, which the finance department had projected would reduce state general revenue by $90 million in fiscal 2023.

Hutchinson said Wednesday, “My goal is to get tax relief to the largest number of Arkansans, particularly those in the low or middle income category.

“The low income tax credit proposal gets more money to those Arkansans and in the same time frame. I support that change,” he said.

The four-pronged tax cut package is now projected by the finance department to reduce state general revenue by $500.1 million in fiscal 2023, by $166.6 million more in fiscal 2024, by $69.5 million in fiscal 2025, $18.4 million in fiscal 2026, and $8.4 million to eventually provide total tax relief of $763 million a year.